WDP50April 1989

50 U World Bank Discussion Papers

Lessons of FinancialLiberalization in Asia

A Comparative Study

Yoon-Je ChoDeena Khatkhate

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5 0 World Bank Discussion Papers

Lessons of FinancialLiberalization in Asia

A Comparative Study

Yoon-Je ChoDeena Khatkhate

Thc World BankWashington, D.C.

Copyright © 1989The World Bank1818 H Street, N.W.Washington, D.C. 20433, IJ.S.A.

All rights reservedManufactured in the United States of AmericaFirst printing April 1989

Discussion Papers are not formal publications of the World Bank. They present preliminaryand unpolished results of country analysis or research that is circulated to encourage discussionand commnent; citation ancl the use of such a paper should take account of its provisionalcharacter. The findings, interpretations, and conclusions expressed in this paper are entirelythose of the author(s) and should not be attributed in any manner to the World Bank, to itsaffiliated organizations, or to members of its Board of Executive Directors or the countriesthey represent. Any maps that accompany the text have been prepared solely for theconvenience of readers; the designations and presentation of material in them do not implythe expression of any opinion vvhatsoever on the part of the World Bank, its affiliates, or itsBoard or member countrics concerning the legal status of any country, territory, city, or areaor of the authorities thereof or concerning the delimitation of its boundaries or its nationalaffiliation.

Because of the informality and to present the results of research with the least possibledelay, the typescript has not been prepared in accordance with the procedures appropriate toformal printed texts, and the World Bank accepts no responsibility for errors.

The material in this publication is copyrighted. Requests for permission to reproduceportions of it should be scent to Director, Publications Department at the address shown inthe copyright notice above. The World Bank encourages dissemination of its work and willnormally give permission prornptly and, when the reproduction is for noncommercialpurposes, without asking a fee. Permission to photocopy portions for classroom use is notrequired, though notification of such use having been made will be appreciated.

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, andcountries and regions; it is of value principally to libraries and institutional purchasers. Thelatest 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., orfrom 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 SouthAmerica. I. Khatl.hate, Deena R. II. Title. III. Series.HG1230.8.C48 1989 332-4'95 89-5772ISBN 0-8213-1209-X

iii

Table of Contents

Page No.

Executive Summary .................................................. v

I. Introduction ............................................... 1

II. Macroeconomic Background and the Financial Sectoron the Eve of Financial Liberalization .................. 4

III. Instrumentality of Financial Reform ........................ 18

IV. The Conseguences of Financial Liberalization ............... 23

OverviewMacroeconomic BackgroundThe Consequences of Financial LiberalizationLevel and Structure of Interest Rates

Growth of the Financial SectorCompetitiveness, Profitability and Efficiency of

Financial InstitutionsAvailability of Long-term CreditIntegration of Domestic Interest Rates with

Foreign Interest RatesQuality of Banks' PortfoliosThe Corporate Sector's Financial StructureIntercountry Experiences: Divergence and SimilaritySumming Up

V. Financial Liberalization in Chile. Argentina andUruguay: A Comparative PersDective ..................... 72

1. Macroeconomic Environment and the Status of theFinancial Sector

2. The Main Elements of the Financial LiberalizationPrograms

3. Impact of Financial Reforms4. Adjustment Policy Implementation and Its Linkage

with Financial Liberalization5. Financial Liberalization Experience in Southern

Cone and Asian Countries: A Comparative View

iv

Page No.

VI. Lessons of Countries' Experiences from FinancialLiberalization ................................ 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 beenrelatively successful, the Philippines, which has not done well, andIndonesia, which has a mixed record. The experiences of these countries arecontrasted with those of the Southern Cone countries of Latin America: Chile,Argentina and Uruguay. The paper will answer some of the questions raisedabout the nature, content and scope of financial liberalization strategy andpolicies in developing countries, and it will draw pertinent lessons for thosecountries which desire to strengthen their liberalization process as well asfor those which will undertake similar programs for the first time.

2. For the purpose of this paper, financial sector means the bankingsector because of its dominant position in developing countries, thoughnonbank financial institutions, when important, are covered to the extent thatdata are available. The term financial liberalization means substantialreduction of government intervention in setting interest rates and allocatingcredit, either by doing away entirely with the interventionist regime as inthe Southern Cone countries or by gradually phasing it out as in Korea, SriLanka and partly in Indonesia. It may also be mentioned that this paper doesnot discuss allocative efficiency of the liberalized system both because ofthe complexity of issues involved and the scarcity of data.

II. Macroeconomic Background and the Financial Sectoron the Eve of Financial Liberalization

3. Korea undertook financial reforms in 1981-82; Malaysia, towards theend of 1978; the Philippines, in 1980; Indonesia, in 1983; and Sri Lanka, inlate 1977. Though nuances of motivation varied according to the particularcircumstances of each country, reform was basically a response to the realiza-tion by authorities that the interventionist regimes then prevailing wereinefficient and ineffective because the impact was largely circumvented byfinancial institutions through various devices.

Korea

4. Korea's economy grew rapidly in the 1960s and 1970s, spurred bystrong performance of the export sector. Following the first oil shock in theearly 1970s, the balance of payments deteriorated, and investment was financedby massive foreign borrowing. Expansionary monetary policy during these yearsresulted in a high average annual rate of inflation of around 20%. Thenominal exchange rate was pegged to the US dollar during 1974-79; there was a23.6% 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 ofgrowth, had slowed considerably. With the second oil shock, the terms oftrade deteriorated further and the increase in international interest ratesposed serious problems when f'oreign debt was already large.

5. The financial system in Korea, dominated by the Government duringthe 1960s and 1970s, had lbeen used as an instrument of development policy.There was a thriving informal credit market estimated to account for around30% of total bank credit in the 1970s. Nonbank financial institutions (NBFIs)such as investment and finance companies and mutual savings companies wereallowed to be set up in the early 1970s. The securities market's role infinancing investment was marginal.

6. Most interest rates in the organized credit market were regulate' bythe Government through a strict interest rate ceiling. With the inflationrate relatively high and volatile, the real deposit rates were usuallynegative in the 1970s, and lending rates followed a similar pattern.Preferential credits with low interest rates were estimated to account foralmost 30-40% of total bank credit.

Malaysia

7. Unlike Korea, Malaysia had a very stable macroeconomic environmentduring the 1970s. Inflation was stable, and the current account was in acomfortable position during most of the period, especially the latter half ofthe 1970s, owing to the improvement in the terms of trade. However, Malaysi'ahad a chronic fiscal deficit of about 6-7% of GDP during the 1970s, owing tolarge development expenditures and subsidized public enterprises. Malaysiahad a fairly open capital account with a floating exchange rate.

8. The financial institutions in Malaysia operated under predominantlycompetitive conditions. The share of commercial banks in total assets of ihefinancial system was about 40%, while the shares of nonbank financialinstitutions together with the Central Bank totaled about 30%; the restbelonged to provident, pension and insurance funds, savings institutions anddevelopment finance institutions (DFIs). The operations and management ofcommercial banks were, by and large, autonomous, and there was considerablefreedom of competition. Malaysia had a relatively large securities market inthe 1970s, but it was dominated by the issuance of government securities.

9. The growth of the financial sector was accelerated in the 1970s bythe stable rate of real return on deposits, which in turn owed to a stable andlow inflation rate. The Malaysian financial sector was considerably deepened,and the instruments were diverse and sophisticated. Before October 1978, BankNegara of Malaysia (BNM) determined the maximum deposit rates and minimumlending rates of commercial banks, but BNM's control did not adversely affectinterest rates.

vii

The PhilipDines

10. The Philippine economy in the 1970s was relatively stable, with arate of growth of between 6% and 6.5% per year. The Philippines had a chronicdeficit on current account of the balance of payments of around 5% of GNPduring the period 1974-1980, although the nontraditional export sector grewquite impressively. Major external shocks affected the Philippines during theturbulent 1970s. The first oil shock occurred in 1974 and caused highdomestic inflation, The inflation rate was kept stable until the second oilshock of 1980, when it again escalated. The fiscal deficit remained modestduring the 1970s, fluctuating around 1.0% of GDP. The macroeconomic situationwas precarious on the eve of financial reform.

11. The banking sector in the Philippines was relatively free. Theentry of financial institutions was easy until 1970. Between 1970 and 1979,no new banks have been allowed to enter the system. Since then the policyregarding new banks has become liberal. The nonbanking segment of thefinancial system expanded in the 1970s, mainly due to the expansion of moneymarket activities. There was not a strong capital market. By the mid-70s,the development of money market instruments accelerated and attractedsubstantial financial savings. Interest rates were fixed and remainednegative in real terms during most of the period prior to financialliberalization.

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 wasaround 7% on average during 1973-83 because of burgeoning oil revenues andlarge amounts of foreign aid, and Indonesia had an open capital account. ButIndonesia faced serious problems when the oil price boom abated at thebeginning of the 1980s. The external payments position worsened and theGovernment's fiscal deficit ran as high as 2% of GNP during 1980-83.Inflationary pressures, however, were not as serious: the rate was around11%, much lower than the 20% rate prevailing in the 1970s.

13. The Indonesian financial system had considerable depth and breadthon the eve of financial reform in 1982. Though the financial system consistedof deposit money banks including state-owned banks, development banks,insurance companies, saving banks and credit institutions of all types, thelatter accounted for barely 7% of total financial assets. Regulationsgoverning the financial system were numerous. There were ceilings on theinterest rates on deposits and loans of the 8 state banks which accounted foralmost 40% of the total gross financial assets in Indonesia until 1983. Therewere credit ceilings on individual private and foreign banks, and within theoverall credit ceilings there were subceilings differentiated by variouscategories of loans. Furthermore, the most comprehensive regulation was thesystem of subsidized liquidity credits made available to banks to refinancelow-interest-rate loans to priority sectors.

Sri Lanka

14. Until 1977, Sri Lanka was the only country among the five which hadexperienced prolonged stagnation. The inflation rate was as high as 14%,

viii

induced by a large and growing fiscal deficit amounting to almost 8% ofnominal GNP. The balance of payments remained precarious, even with stringentexchange and trade controls.

15. Sri Lanka had a fairly modern financial sector in 1977, with avariegated institutional pattern. Commercial banks, and two state-owned bankswith a 35% share in total financial assets, dominated. The relativeimportance of development banks and insurance companies was small. Regulationof the financial system wits pervasive.

III. Instrumentality of Financial Reform

Korea

16. Financial reforn in Korea was gradual. In 1981, the Governmentbegan to privatize the natiornwide commercial banks by divesting itsshareholdings; by 1983, it had privatized all nationwide city banks. However,the Government maintained de facto monitoring of bank management and creditallocation. Entry of foreign banks was permitted to motivate domestic banksto 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 financialinstitutions to mobilize savings.

17. The interest rate ceiling was adjusted upward in 1979 to yieldpositive real interest rates, although this was frustrated by high inflationin 1980 and 1981 caused by the second oil shock. In 1982, the Governmentabolished all preferential lending rates and unified the bank loan rate at10%; however, preferential access to credit for specific groups of borrowerscontinued. The Korean government has maintained the interest rate ceilingsexcept in special markets such as interbank, unguaranteed commercial bills andcorporate bond markets. The capital account was not liberalized.

Malaysia

18. Commercial banks were allowed to determine their own interest rateson deposits and loans after a new interest rate regime was instituted inOctober 1978. However, the prime rate was controlled by the monetaryauthority during 1978-81. Late in 1981, a new interest rate mechanism basedon the base lending rate (BLR) was introduced. Its introduction signaled thevirtual disappearance of control on the lending rates. From November 1, 1983,all interest rates on loans and advances other than those prescribed bymaximum ceiling rates andL the law were linked to the BLR of the respectivebanks. However, a ceilirng on lending rates was continued for specialcategories of borrowers and for housing loans.

The Philippines

19. In the Philippines, a universal banking system patterned on theGerman model was introduc:ed in March 1980. To facilitate the change, theceiling on various categories of bank lending and deposit rates was firstrelaxed and then removed. Banks which became unibanks were required tobroaden their ownership base. To encourage term lending, controls on interest

ix

rates on long-term loans and deposits were removed first, and later theinterest rates on short-term deposits were removed. The ceiling on rates fordeposits with maturity of two years or less was eliminated in mid-1984, andthe last lending ceilings on short-term loans were removed in January 1983.However, the interest rate subsidy for preferential credit programs wascontinued. In 1985 the Central Bank finally eliminated the subsidy when therate on rediscounting of preferential loans was aligned to the market rate.

Indonesia

20. Indonesia's financial reform was implemented in two stages. Thebeginning was made in June 1983, and the second stage commenced in 1984. TheJune 1983 reform had three principal components: (a) elimination of ceilingson bank credits; (b) gradual narrowing of loan categories from access to BankIndonesia (BI) liquidity credits; and (c) deregulation of state banks'interest rates on most categories of deposits and on all loans except a fewpriority loans. The two elements of the subsequent reform, which was more ina nature of a follow-up, were: (a) introduction of rediscount facilities andBI certificates called Servifikats Bank Indonesia (SBI); and (b) introductionof new money-market instruments, Surat Berharga Pasar Uang (SBPU), in February1985.

Sri Lanka

21. The emphasis of the financial reform in Sri Lanka was on removal ofrestrictions on interest rates. This was done by first raising the bank ratefrom 8.5% to 10% p.a., thereby giving a signal to other market rates ofinterest. This was followed by sharply raising the interest rates on depositsof the National Savings Bank (NSB), a pace-setter. The Central Bank of Ceylonrestricted access of banks to its credit to 4% of selected items of assets asof September 30, 1977; the limit was subsequently raised to 7%, and anyborrowing beyond this limit was charged a penalty rate of 15%. At the sametime, the basic exchange rate and the premium value (FEEC) were first unifiedat an initial rate of SLR 16 to the US dollar, and then the rate was allowedto float. Exchange controls, too, were considerably diluted.

IV. Consequences of Financial Liberalization

22. The consequences of liberalization for the financial systems in thefive countries are discussed at a disaggregated level. The areas chosen fordisaggregation are: (a) the level and structure of interest rates; (b) growthof the financial sector; (c) competitiveness, profitability and efficiency offinancial institutions; (d) availability of long-term credit; (e) integrationof 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 thefive countries was in a desired direction. In Korea, interest rates remainedsubstantially positive, mainly because of a decline in the inflation rate andflexibility in interest-rate management. The approach to deregulation ofinterest rates was pragmatic, as evident from the fact that the banks'

x

interest rates were quickly adjusted downward, even in the face of highinflationary expectations, when the financial vulnerability of the corporatesector seemed to react adversely on the banks. On the other hand, dismantlingof preferential interest rates and partial. liberalization of interest rates inthe nonbanking sector have facilitated the integration of formal and informalmarkets. The impact of liberalization on domestic interest rates in Malaysiawas modest at the beginning because market: forces before liberalization had astrong influence on them and the difference to be made up by a further rise ininterest rates was limited. After the new interest rate mechanism based onBLR was introduced in 1981, bank deposit rates became more sensitive tointernational interest rates. The integration of interest rates was moreconspicuous in regard to deposit rates. However, the segmentation of interest:rates between those for banks' assets and liabilities and those for governmentsecurities was limited. The term structure of interest rates changedsignificantly, particular:Ly due to a stable inflation rate. In thePhilippines, though the nominal interest rates on bank deposits and loansincreased marginally at first, the real interest rates became positive as theinflation rate declined. But: the upward movement of interest rates wasinduced in part by the severe monetary contraction following the liquiditysqueeze and in part by the high yield on Central Bank bills with which thebanks had to compete. During 1984-86, market-determined interest rates werehigher than the real return on investment. Domestic interest rates werelargely well integrated. In Indonesia, t!he main impact of liberalization wason the interest rates on assets and liabilities of the state banks, since theother banks' rates were freely determined even before liberalization. Realinterest rates became positive and remained high. Domestic interest rateswere well integrated. Sri Lanka followed other countries in regard to depositinterest rates, which became strongly positive after liberalization. Thoughgovernment intervention was continued, market forces were given greaterinfluence on the level of interest rates.

Financial Sector Growth

24. The beneficial consequences of financial reform can be seen in thefaster 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 theM2/GNP ratio, implying that nonbank financial assets, particularly corporatebonds and commercial papers, expanded rapidly. In Malaysia, the ratio ofM3/GNP, which included time and savings deposits of nonbanks, more thandoubled. In the first flush of financial reform, the financial system in thePhilippines expanded moderately. Since 1984, however, its growth rate hasturned negative in the context of an adverse macroeconomic environment, aliquidity crisis and widespread bank failures. In Indonesia, the gross assetsof the organized financial sector almost tripled since 1982, and the range ofnoncredit financial services widened considerably. Only in Sri Lanka did thefinancial system not record any perceptible growth, but financial reformssucceeded in stemming the decline of the financial system.

25. From the above, it is clear that growth of the financial sector inKorea, Malaysia and, to some extent, Indonesia has been rapid when the levelof real interest rates has been high and stable. This again points to theimportance of stable inflation rates. The Philippines, which had highlyfluctuating inflation during 1983-85, experienced contraction of the financialsector 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 fluctuatingand high inflation in the later stages of reform. Japan and Taiwan, whichhave achieved rapid financial sector growth during the last two or threedecades despite their controlled banking systems, also had a very low andstable inflation rate. This suggests that a relative price stability may beas crucial as the deregulation of the interest rates per se to the achievementof sustained financial sector growth.

Competitiveness of the Financial System

26. Following liberalization, competitiveness of the banking systemincreased in all the five countries, though the degree of increase varied fromcountry to country. In Korea, use of new financial instruments by privatizedbanks and NBFIs, expansion of the direct credit market and freer entry offoreign banks were the main catalysts in promoting competition. In Malaysia,competitive forces were boosted by liberalizing banks' interest rates, makingthe competition between banks and NBFIs more intense. The expansion ofbranches by banks and the relative increase of the share of small banks whenthe prime rate was controlled also contributed to greater competition. Theentry of foreign banks was another contributory factor. In the Philippines,where the bank concentration was prevalent even before liberalization, it wasreduced after the advent of universal banking and, to some extent, therestructuring of two largest government-owned banks. However, the basicoligopolistic structure persisted even after financial liberalization. InIndonesia, the main factor that spurred competition among banks was theabolition of controls on deposits and loan interest rates of state banks whichhad major share in total financial assets. In Sri Lanka, the interbank marketacquired new strength as new instruments emerged and foreign currency bankingunits (FCBUs) were established and foreign banks were allowed to operate.

Term Credit

27. The impact of liberalization on availability of term credit was notuniform across the five countries. In Korea, there was a distinct improvementin the flow of term credit from nonbanks such as insurance, investment andtrust companies (whose growth was accelerated) and the securities market. InMalaysia, however, the securities market as a source of long-term fundsremained marginal: it was crowded out by the issue of government bonds soldto captive markets. In addition, the share of development financeinstitutions in total credit was very small. The Philippines' experience wasmixed. Long-term funds from banks were augmented when reserve requirements onlonger term deposits were lowered and bank loan rates were deregulated,thereby attenuating mat4irity risks. With the extension of the averagematurity of deposits, the banks' ability to provide such funds was greatlyenhanced, though since 1985 political turbulence, adverse macroeconomicdevelopments and financial fragility of banks have reduced the banks' role inthis area. In contrast, in Indonesia the banks were constrained to lendmedium and long by the pronounced volatility of interest rates and themismatch of maturities between liabilities, predominantly of short-termnature, and the loans required for investment financing. The capital marketdid not develop due to lack of infrastructure facilities. In the more liberalfinancial conditions in Sri Lanka, banks and development banks made up thesingle 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 thelack 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 havesignificantly improved the availability of long-term credit, mainly becausethe maturity of loans tended to be shortened whenever the inflation rate washigh and volatile, as in Indonesia and the Philippines. Further, if the bankshave to consider medium- cnd long-term lending (Indonesia), interest rateshave to remain stable. To enhance the availability of long-term credit andrisk capital, the encouragement of new instruments and new markets seems to benecessary along with stable inflation and interest rates.

Intermediation Cost

29. The experience of these five cotntries in regard to intermediationcost was diverse to a degree that nothing definitive can be said about howliberalization influenced it. In Korea, the cost of intermediation mighthave, on balance, fallen, determined as it was by two factors opposed to eachother such as the scaling down of reserve requirements and increasing lossesfrom nonperforming loans. In Malaysia, there was evidence that theintermediation margin widened slightly after reform (instead of narrowing asexpected) because of the perpetuation of the oligopolistic banking structure.In addition, the widened margin could be explained by the rise in the overheadcosts of banks caused by rapid branch expansion and continuation of selectivecredit programs. In the Philippines, the cost of intermediation rose, but thereason was different. The increase was due to fiscal imposition, such as highreserve requirements, the substantial tax on gross receipts and hugenonperforming assets. In Indonesia, the efficiency of intermediation appearsto have increased, judging it: by the reduction in the interest rate margin.The interest rate margin narrowed because of the reduction in the interestrate margin on both performing and nonperforming loans. In Sri Lanka, theinterest rate margin declined slightly after financial reform. Consideringthat reserve requirements were quite high, even a small downward change in theinterest 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 domesticinterest rates with foreign :interest rates were different for each of thecountries and were not always in a direction which could have been expected ona priori grounds. Following financial reforms and a substantial devaluationof the currency, the gap between the domestic and foreign interest rates inKorea declined and reversed, and foreign interest rates exceeded domesticones, a situation quite opposite the one prevailing in the 1970s. However,the Korean interest rates could not be considered sensitive to the extentexpected to international interest rates because of the control on capitalmovements, a distinguishing feature of Korea's financial reform. Whiledomestic interest rates in Malaysia were quite sensitive to interest ratedifferentials between that country and abroad, the degree of sensitivity wasnot as high as expected, presumably because the nonbank public had littleaccess to foreign markets. The Philippines' experience was mixed. The costof borrowing domestically exceeded that of borrowing abroad in the 1980s, andthe gap widened due to the volatile movement of the exchange rate, residual

xiii

controls on exchange rates and uncertainty about inflationary pressures. InIndonesia, the reverse happened and the foreign interest rates, when adjustedfor depreciation, were lower than those in the domestic markets, though thegap was narrow. The situation turned around after financial reform, and thecost of borrowing abroad exceeded that in the domestic markets as a result ofa series of devaluations. In Sri Lanka, the domestic interest rates matchedforeign rates except in two years, 1985 and 1986, when the foreign interestrates rose more sharply than domestic ones. On the whole, it is possible toconclude that following financial liberalization, although the influence offoreign factors on domestic interest rates increased, full integration ofrates did not take place even when capital movement was almost free, as inIndonesia, Malaysia, and the Philippines.

Ouality of Bank Portfolio

31. All five countries were saddled with nonperforming loans to varyingdegrees, with the Philippines bearing the greatest burden and Malaysia thelightest. The manner in which the problem of nonperforming loans was handledalso was different. In Korea, the problem of nonperforming loans wasgradually resolved without major impact on the solvency of banks. This waslargely due to substantial financial support from the Government, taxallowances for writing off bad debts, concessional credit by the Central Bankto commercial banks, restructuring measures adopted to rescue the corporatesector, and also partly because of the onset of a strong economic recovery.Nonperforming loans never assumed large dimensions in Malaysia, and nominalinterest rates were never too high. The corporate sector was less exposed tothe shocks of higher interest rates. However, since 1985, as real interestrates increased and the economy slowed, the burden of arrears has grown. Inthe Philippines, the banking system virtually collapsed, and the Central Bankhad to undertake a sizeable bail-out operation. The Indonesian financialsystem also faced the serious problem of a growing volume of bad and doubtfulassets in bank portfolios. The main reason for this was the high level ofinterest rates in relation to the productivity of capital. This had anadverse impact on the corporate sector first and later on the financialsector. In Sri Lanka, also, the poor quality of bank portfolios posed aserious problem, but it remained manageable partly because regulation of thefinancial system was prudent and strict, and the Government's other actionswere timely.

Corporate Financial Structure

32. The impact of interest rate deregulation affected each of the fivecountries differently because of the difference in the leverage of thecorporate structure. Of the five countries, the corporate sectors in two, thePhilippines and Indonesia, had a high gearing ratio on the eve of financialliberalization. The ratio increased, mainly due to distress borrowing,thereby making it more sensitive to changes in interest rates. In Korea'scase, the debt/equity ratio declined from its prereform-period level inresponse to the receding government commitment as a risk partner followingprivatization of banks. In Malaysia, the corporate debt/equity ratio wasrelatively low and declined somewhat after the reform.

xiv

V. Financial Liberalization in Chile. Argentina andUruguay: A Comparative PersRective

33. For a comparative view of financial liberalization in the five Asiancountries, three countries of Latin America's Southern Cone, Chile, Argentinaand Uruguay, were studied. They pursued similar financial liberalizationstrategies and up-front stabilization policies, with minor differences intheir timing. In Chile, 'both policies were initiated concurrently in 1974,while in Argentina and Urugualy financial reform policies preceded thestabilization policies.

34. On the eve of the financial reform, these three countries were in aneconomic 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-accountdeficits. The economy suffered from repressive policies. Price and exchangecontrols were pervasive, and the financial sector suffered from heavyintervention. 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. Thefiscal deficit was 12% of' GDP. The balance of payments was also under seriousconstraint. Uruguay's economy was equally severely afflicted by macroeconomicimbalances. The average growth rate of GDP during 1971-75 was 1.6% p.a., andterms of trade declined. The fiscal situation was serious enough to spark offcapital flight. The average annual balance of payments deficit was 1.6% ofGDP.

35. In such a milietu, the financial sectors in all three countries werestunted by repressive intervention. In Chile, the regulated interest ratesdid not respond to changes in the inflation rates and were negative in realterms since the 1950s. Argentina's financial system was repressed andantediluvian. 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 sectorwas 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. Reserverequirements were simplifiecl and progressively scaled down, and otherconstraints which were instrumental in repressing the financial structure wereeliminated. Preferential credits from the Central Bank were drasticallycurtailed, and the refinancing rate on remaining credit was raised to themarket level. All categories of financial institutions were progressivelypermitted to compete for business, and access for new entrants to thefinancial sector was made ealsy. Controls on capital movement were noteffectively phased out until 1979. Strong stabilization policies were adoptedto reduce the fiscal deficit and slow the depreciation of the exchange rate.Argentina and Uruguay followed a similar path toward reforms. Both interestrates and capital movements were decontrolled. In Argentina, minimum legalrequirements were lowered in two stages between 1977 and 1979. Financialinstitutions were given full freedom to manage their liabilities, selectivecredit policies were substantially reduced, and active measures were taken toensure that financial intermediaries adjusted smoothly to competitiveconditions. Entry restrictions were relaxed gradually. Adjustment policies

xv

which came later, with an accent on eliminating the balance of paymentsdisequilibrium, effected a steady exchange rate depreciation through scheduledremoval of reserve requirements on foreign loans. Uruguay's reform was across between gradual intervention and the full and complete deregulation inChile and Argentina, respectively. Along with a flexible exchange rate policydesigned to attain a sustainable balance of payments, the authorities began tounravel the ceilings on interest rates in stages, the first in April 1976 whena uniform ceiling of 62% replaced all existing ceilings on liabilities andassets of financial institutions. The ceilings were raised to 90% in November1977, 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. Theratio of total financial assets (including paper issued by banks, developmentbanks and financiers) to GNP more than doubled between 1975 and 1982. Evenmore important, financial assets other than M2 as a proportion of totalfinancial 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 offinancial institutions relative to the Government in mobilizing savings.While the process of financial intermediation became vigorous, the averagematurity of financial instruments shrivelled. In the initial flush ofreforms, the Argentine financial system reacted well to the market incentivesof higher interest rates and competitive conditions. The ratios of M3/GDP andM2/GDP increased substantially during 1977-79. In Argentina too, the impactof financial reform on the financial intermediation process was magnified bythe 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 andcontinued upward until 1982. However, as in Chile and Argentina, the spurt inthe 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 Chilebecame positive for the first time since the 1950s, and they remained so until1984. Loan rates were substantially higher in both nominal and real terms,reflecting the oligopolistic nature of the banking system and its bank holdingstructure dominated by a limited number of economic "groups" despite growingcompetition between banks and nonbanks following liberalization. Thoughnominal interest rates were even higher than Libor after adjustment fordevaluation which emphasized a weak link with the international financialmarkets. Nominal interest rates in Argentina increased very sharply but, withthe inflation rate running ahead of nominal interest rates in most of theyears after 1976, positive real interest rates were attained only in 1977 andagain during 1981-83. The ex Rost peso/dollar spread was positive except in1971 and in 1981-82. This indicates that both nominal and real domesticinterest rates were higher in Argentina than foreign rates. Bank nominaldeposit and loan rates surged up in Uruguay, but loan rates recorded a muchhigher 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 indicatedthat domestic interest rates, both nominal and real, were usually higher thanforeign interest rates.

Nonperforming loans

40. Since Chile's financial system was liberalized, the single mostimportant development has been the staggering growth of debt accumulation bythe 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 itsown momentum, spurred by t:he intrusion of factors such as the dominance of thefinancial and manufacturing conglomerates. Banks lent to the firms whichowned the banks, and such loans constituted around 20% of the banks'portfolios. With excessively high interest rates and continuous overvaluationof the peso, bankruptcies became common and the banks' portfolios soured. Theauthorities reacted to the crisis by taking a series of measures: an outrightbail-out of affected banks, provision of emergency loans and subsidizedcredit, purchase of risky loans by the Central Bank, and a host of otherrescue measures, including the return of :Lnterest rate guidance by the CentralBank. The genesis of the nonperforming loans and their rapid expansion inArgentina was similar to that in Chile. The basic cause, again, was theunsustainably high level of interest rates, both nominal and real, which,together with the appreciated real exchange rate, made it unrewarding forborrowing firms to continue production activities. The situation wasaggravated by the high gearing ratios of firms. This high ratio magnified theimpact of high interest rates on profit margins of firms, and their distressborrowing raised indebtedness to banks. As a result, bad and doubtful debtsas a percentage of total bank loans accelerated from 1.95% in 1975 to 9.13% in1980. Here again, as in Chi:Le, the Central Bank played a crucial role throughinjecting Central Bank credit into the affected banks through a refinancingand subsidy scheme and by fixing interest rates to make them negative in realterms. The basic causes in Uruguay, i.e., high interest rates and theovervaluation of the real exchange rate, were similar to those in Chile andArgentina, and the economric and institutional conditions were also verysimilar. The adverse impact of this development was not assessed properly byUruguay's banks, and they continued to finance the purchase of overpricedassets. When the borrowing firms could not repay their loans on time, thenonperforming loans began to mount. The result of these factors, thefinancial systems in these countries collapsed. Inevitably, the Central Bankinjected its credit into the systems to revive them.

Lessons from Financial Liberalization

41. Several important lessons can be drawn from financial liberalizationacross countries. First, price stability and, more broadly, macroeconomicstability, is the linchpin of successful liberalization, not the deregulationof interest rates Rer se. especially when the countries undergoing financialreforms have shallow financial markets. In the Philippines, Malaysia andChile, the control of inflation was a determining factor in attaining positiveinterest rates. The adjustment in real interest rates lagged when inflationwas declining with interest rates fully liberalized, and this adverselyaffected the profitability of firms and at second remove the stability of thefinancial system. In Korea, by contrast, interest rates were administered bythe Government by adjusting nominal interest rates according to the movement

xvii

of inflation. This together with the capacity of firms to repay their debthelped to preserve the stability of the financial system. It is also clearthat financial liberalization, if not properly designed, may cause instabilityof the financial system, which in turn may magnify macroeconomic instability,as in Chile, Argentina and Uruguay. Among the Asian countries, the experiencesof Indonesia and the Philippines reflect the two-way effects of the macroenvironment and financial reforms on each other. Indonesia's macroeconomicimbalances were severe when reforms were initiated, but they were corrected bythe initial impact of the reform. However, its troubles were lateraccentuated when continually high domestic interest rates led to an increasingloan default rate. In the Philippines, macro- and microeconomic policiescombined to accentuate the financial crisis. Second, when capital movementsare completely free in an economy where the financial market is relativelysmall, liberalization of domestic interest rates makes them upwardly sensitiveto the pressures of expectations of exchange rate. On the other hand, if agovernment attempts to control domestic interest rates, it may risk massivecapital flight. The best approach may be to achieve a stable macroeconomicenvironment which will eliminate any abrupt changes in expectations aboutexchange rate movement. When this is not possible, a country with a small andvulnerable financial market and an unstable economy may choose a second-bestapproach of continuing some restrictions on the capital account and oninterest rates, as in Korea. If a country has already liberalized the capitalaccount, it should maintain macroeconomic stability at all costs.

42. Third, financial liberalization based on the banking system hasinherent limitations. Interest rates cannot be raised without inviting undueadverse risk selection among borrowers and creating moral hazards for thebanking system. This is particularly so when a monetary policy directedtowards control of inflation needs to be tightened considerably.

43. Fourth, the excessively high positive real interest rates are asdisequilibrating as the heavily repressed negative real interest rates. Inthe imperfect and oligopolistic money and credit markets characteristic ofdeveloping countries, a sudden dose of liberalization often leads to theovershooting 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 toincreasing arrearage of the banking system as borne out by experiences in theSouthern Cone countries, the Philippines and Indonesia. Fifth, a M2 or M3/GDPratio as an indicator of deepening or broadening as a consequence of financialliberalization may at times be misleading. To the extent that the ratioreflects the impact of the short-term inflow of foreign savings, as happenedin the Latin American countries, Indonesia and the Philippines, the upwardchanges in that ratio cannot be taken to represent enhanced efficiency ofresources mobilized by siphoning them away from less productive uses. InLatin America, the so-called dollarization after capital controls were removedspotlighted both the weakness of the financial system and the efficacy ofmonetary policy. Sixth, it should be recognized that in economies which havea long history of financial repression, the participating actors, be they bankmanagers, borrowers, lenders or public servants, are not trained in new waysof dealing with a liberal and competitive system. For instance, it wassuggested that in Chile's case some of the blame for a disastrous financialcrisis resided in little experience existing in the country in the managementof 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 forinformation flow, legal and aLccounting systems and an appropriate regulatorysystem to monitor it careEully and continuously. Otherwise, financialliberalization will fail Ln its main purpose: to orient the financial systemtowards greater competition amd efficiency. In the case of banks, it is notalways possible to distinguish a necessary control for monetary stabilitypurposes from a supernumerary regulation affecting credit allocation, but itis imperative that regulation and supervision be strictly enforced.

44. Seventh, financial liberalization in developing countries should notbe considered a replica of liberalization of financial markets in the highlyindustrialized countries because of important differences in the financialsystem as a major source of fiscal revenue and nonbank capital marketdevelopment in the industrial countries. In view of these structuraldifferences, liberalization in developing countries brings about greaterprudential risk, concentration of ownership and moral hazards. Theimplication is that a gradual process of liberalization in developingcountries is to be preferred to the sudden dismantling of all regulationsconsidered repressive. Eighth, the financial reform experience in differenttypes of economies shows tha,t a pragmatic solution may be to evolve a certainset of market oriented indicators based on fuller information from domesticand 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 andgradual, does not seem to make any significant difference to the volume ofsaving and investment activities in the liberalized economies. No systematictrend or pattern in regard to the size of saving and investment is discoveredin the countries surveyed, though reform seems to have greatly contributed tothe 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 greetedexperiments of financial liberalization during the 1970s and early 1980s inseveral LDCs, but there is now skepticism about the effectiveness of suchreforms because of the economic and noneconomic circumstances prevailing(V. Galbis, 1986; J. Galvez, and J. Tybout, 1985; R. Mckinnon andD. Mathieson, 1981; R. McKinnon, 1986 and 1988). Growing mistrust aboutfinancial liberalization triggered by unsavory experiences in Argentina,Chile, and Uruguay, (V. Corbo and J. de Melo, 1985; V. Corbo, 1985) can betraced to the questioning of its analytical underpinnings, even though someAsian countries such as Indonesia, Korea, Malaysia, the Philippines andSri Lanka have benefitted from financial liberalization. It is thereforerewarding to analyze the experiences of these countries to understand theanatomy of successes and failures. Appropriate lessons can be drawn forreplicating similar reform policies in other financially repressed economies.

1.2 The nature and content of financial liberalization policies haveevolved by way of reaction to the financial repression policies that were invogue in many less-developed countries during the 1950s and 1960s. In thecontext of growth, money is treated as part of wealth, which is considered inthe earlier economic literature to compete with accumulation of physicalcapital. Since output growth is crucially dependent on physical capital,accumulation of money balances is deemed unproductive, and an appropriatepolicy contributing to output and growth is to tax the accumulation of moneybalances by expanding the money supply. Chile monetary expansion was thecentral focus in policy formulation, there had been widespread recourse inmost developing countries to the maintenance of low interest rate policiesthrough ceilings on interest rates and credit allocation by guidance of thecentral banks of Governments concerned. Both of these approaches to creditpolicy were motivated by the "market failure" arguments and the inadequacy ofthe existing financial environment to facilitate sharing the risks involved innew investment. Social rates of return on investment tend to diverge from theprivate rates of return, and they can be equalized only through interventionsof one kind or another. Likewise, the type of financial system the developingcountries have does not permit risky investment. As a result, ceilings onnominal interest rates paid and received by banks and the allocation of creditwere 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 becauseof their narrow tax base and of lack of expertise in tax administration andexpenditure controls. Governments typically bolster their finances by usingan inflation tax imposed through monetary expansion, reserve requirementsimposed on banks (which adversely affect their profitability or is passed onto 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 countriesduring the 1960s and early 1970s, particularly in some Latin Americancountries, eroded the growth of their financial systems. This erosion

2

ricocheted on the real economy, slowed growth and caused deterioration inexternal accounts. In 1973, a new paradigm in the design of financialpolicies emerged. Its theoretical underpinnings were provided by the work ofMcKinnon and Shaw (R. McK:Lnnon, 1973; E. Shaw, 1973). According to theirtheory, pervasive government and central bank regulation tends to distortfinancial markets, and thls distortion in turn adversely affects saving andinvestment decisions of market participants. Subsidized interest ratesdepress saving by depositors and promote inefficient investment through lowborrowing cost of scarce capital. In the same way, credit allocationdecisions are unduly influenced by political and other noneconomicconsiderations. All this leads to fragmentation of financial markets and evento financial disintermediation to the extent that financial assets becomeunremunerative. This phenomenon has now come to be known as financialrepression. It can be attenuated if authorities liberalize the regulatoryregime by allowing interest rates to attain their true equilibrium level andby determining credit allocation on the basis of viability and productivity oEprojects bearing market-determined interest rates.

1.5 The new orthodoxy has held sway since the mid-1970s. Severalcountries in Latin America, Argentina, Chile and Uruguay in particular, andAsian countries like Indonesia, Korea, Malaysia, the Philippines and Sri Lankahave embarked on financial reforms of varying intensity as part of a broaderliberalization strategy. If there were differences among these countries intheir quest for liberalization, they were only in regard to speed, mode andmagnitude.

1.6 The outcome, diverse and differently patterned, was not sufficientlyuniform to make confident predictions about the advisability or inevitabilityof financial liberalization in the countries where financial repressions onceprevailed. There liberalization appeared to have succeeded according to theusual 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 incountries where it failed. In the latter category were Argentina, Chile,Indonesia and the Philippines, where real interest rates no doubt becamepositive but either their level remained too high or they were so volatilethat they deterred new investment. Bank loans went to nonviable andunproductive projects and, as a result, bad debts became rampant andunsustainable. Businesses and banks experienced widespread bankruptcies. Tosave depositors, financial institutions and indebted industries from theresulting financial distress, the very government interventions thought to beresponsible 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, andsuccess in only a few like Korea, Malaysia, Sri Lanka and Indonesia (withKorea an outstanding success, and Indonesia a modest one) have necessitated areassessment of the philosophy of financial 'Liberalization. Two kinds ofreaction are prominent. The dominant of these emphasizes the benign characterof financial reform. Though liberalization experiments have failed in manycountries, their failure was due to adverse factors which supervened in theprocess. First, some macroeconomic policies such as exchange rate and fiscalpolicies 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 onlyone sector of the economy (such as the financial sector) unaccompanied bysimilar reforms in trade, industry, and the labor market had a limited chanceof success and in fact might have been counterproductive. Third, the designand sequencing of reform measures might have been wrongly formulated(A. Swoboda, 1986; R. McKinnon, 1982 and 1988). Finally, the regulatoryapparatus might not have functioned in a manner conducive to the smoothprogression of reform policy implementation (M. Dooley and D. Mathieson, 1987;A. Swoboda, 1986). In short, this kind of reaction does not question thelogic of reforms but implies that other policies could well have deliveredwhat was expected of financial reform.

1.8 From another perspective, there has been pronounced disillusionmentwith financial liberalization, though this view is confined to a minority ofpolicy makers and academicians. This sober view implies that a degree ofstate intervention is inevitable in the institutional structure of developingcountries. Even financial liberalization cannot dispense with it, as wasshown 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 andwidespread failures for a variety of reasons in many others have reopened thedebate about the nature, content and scope of financial liberalizationstrategy and policies in developing countries. Several questions are raised:Is financial liberalization interpreted in a right way, or is it merely atheoretical abstraction unrelated to the objective conditions prevailing inthe financial markets of developing countries. Is financial liberalizationsupposed to remove the restrictive regime at one fell swoop in order to createa competitive financial structure? Is the design of financial liberalizationthat has been applied simply a transplant from the industrialized countrieswith their well-developed money and capital markets? Are financialliberalization objectives thwarted by the unfavorable outcome in macroeconomicpolicies, or are such inconsistencies unavoidable because of the intrinsicoligopolistic character of the LDCs' financial systems?

1.10 Answers to these questions will determine the worth and usefulness offinancial liberalization strategy and may unravel its inner strength andrationality. Answers can be given only if there is a convincing and soundempirical validation of these policies. The purpose of this paper is to doprecisely that by analyzing the experiences of countries where financialliberalization has succeeded (Korea, Malaysia and Sri Lanka), a country whichhas overtly not done as well (the Philippines), and a country which has amixed record (Indonesia).

1.11 Three issues need to be clarified at the outset. For the purpose ofthis paper, financial sector means the banking sector, since banks are thedominant financial intermediaries in developing countries. This does not meanthat nonbank financial institutions are excluded. Wherever such institutionsplay an important role, they are covered to the extent that data areavailable. The second issue concerns how financial liberalization is to bedefined, particularly when the term financial liberalization is subject tovarious interpretations. In the broad sense in which Professor McKinnon usedit in his work referred to earlier, financial liberalization means substantial

4

reduction of government intervention in regard to interest rates and creditallocation. This may mean either doing away entirely with the interventionistregime, 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 issuerelates to the allocative efficiency of tlhe liberalized credit system. Thoughthis is important, it is not discussed in this paper in view of its complexityand the scarcity of relevant data essential for its analysis.

1.12 Section II focuses briefly on the macroeconomic and financial sectorbackground and on the motivation behind financial liberalization in Korea,Indonesia, Malaysia, the Philippines and Sri Lanka to see whether initialconditions influenced the consequences of liberalization in any important way.Section III dealt with the instrumentality of financial reform. Section IVdiscusses the consequences of financial liberalization measures in terms oftheir impact on the level of real interest rates, growth of the financialsector, resource mobilization, intermediation costs, integration of variousdomestic interest rates between banks and nonbanks and domestic interest rateswith foreign interest rates, progress in regard to term credit and thecompetetiveness of the banking system. This discussion is detailed to theextent that necessary information is available for each of the countries. Theimpact of financial reforms will be seen against the backdrop of relevantmacroeconomic developments.

1.13 Section V places what has been observed in the countries concerned inthe course of financial liberalization into a comparative perspective bydrawing attention to the salient features of the financial liberalizationexperiences of some Latin American countries like Argentina, Chile, andUruguay, where the macroeconomic and institutional circumstances weredifferent. Section VI spells out what can be learned from the empiricalevidence in regard to financial liberalization policies and the instruments oftheir implementation in the countries covered. This section will draw generalanalytical conclusions about why the outcome of financial liberalization wasnot always as expected according to the economic rationale embodied infinancial liberalization literature.

II. MACROECONOMIC BACKGROUND AND THE FINANCIAL SECTORON THE: EVE OF FINANCIAL LIBERALIZATION

2.1 This section spe'lls out briefly the macroeconomic background andfinancial systems prevailing in each of the five Asian countries to bediscussed so that the financial reforms and their consequences can beunderstood 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 bythe authorities to the realization that the interventionist regime wasinefficient and ineffective: its impact was largely circumvented by banksthrough various devices.

5

Korea

2.2 The Korean economy grew rapidly in the 1960s and 1970s. Real GNPgrowth 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 maininstruments used to achieve this growth rate were special tax incentives and apreferential credit program. Following the first oil shock in the early1970s, the balance of payments deteriorated and investment was financed bymassive foreign borrowing. An expansionary monetary policy during these yearsresulted 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, andthere was a 23.6% appreciation of the real effective exchange rate between1973 and 1979 (V. Corbo and S. Nam 1986). With the balance of payments in badshape, transactions on the capital account were tightly controlled by theGovernment to prevent capital flight. The end of the 1970s saw Korea at acrossroad. The export sector, the main engine of growth, had slowedconsiderably, massive investment in the heavy and chemical industries hadresulted in a wasteful excess of capacity. With the second oil shock, theterms of trade deteriorated further and the increase in international interestrates posed serious problems since foreign debt was already large. Theinflation rate accelerated, resulting in negative real interest rates. Inorder to correct this situation, the Government adopted comprehensive measuresfor economic stabilization and financial reform in the spring of 1979. Theseincluded 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 duringthe 1960s and 1970s. It was used as an instrument of development policy andincluded various types of Government intervention. Korea's financial systemwas composed of the Central Bank (Bank of Korea), commercial banks (nationwidecity banks, local banks and foreign banks), special banks such as developmentbanks and small and medium-size industry banks, nonbank financial institutions(NBFIs) (investment and finance companies, mutual savings companies, merchantbanking corporations, life insurance companies, etc.). Of these, nationwidecity banks had a majority shareholding by the Government, while local banksand other nonbanks were privately owned. The relative shares of theseinstitutions are shown in Appendix Table Korea 5. Besides, there was athriving informal credit market estimated to account for around 29% of totalbank credit (D. Cole and Y. Park, 1983). The NBFIs such as investment andfinance companies and mutual savings companies were allowed to be set up inthe private sector to support the informal credit markets. The securitiesmarket developed rapidly since 1972, though its role in financing investmentwas marginal.

2.4 Most interest rates in the organized credit market were regulatedthrough a strict interest rate ceiling. With the inflation rate relativelyhigh and volatile, both the real deposit and lending rates were usuallynegative in the 1970s, and lending rates followed a similar pattern (AppendixTable Korea 3). Preferential credits, the interest on which was even lowerthan the rates charged on general bank loans, were estimated to account foralmost 50% of total bank credit. It was not surprising, therefore, that thegrowth of the Korean financial sector relative to the real sector was stagnantdespite a sharp increase in the national saving rate in the 1970s. The M2/GNP

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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 -1.061WHILIWIMES -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 3.311SRI 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 4.561PHILIPPINES 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. Onthe other hand, the nonbanking financial sector grew faster than the bankingsystem, 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 TableKorea 8).

2.5 Liberalization of Korea's financial sector in 1981-82 was implementedin conjunction with overall economic liberalization and adjustment policies.The realization that government intervention tended to yield a diminishingreturn as the economy became more complex was the leitmotif behind liberaliza-tion. There was a growing feeling among the policy makers in the 1970s thatgovernment ownership of the commercial banking system and excessive interven-tion in the financial sector operations were causing inefficiency in resourceallocation and a consequent waste of resources through rent-seeking activi-ties. The control mechanism was increasingly ineffective because the Koreaneconomy 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 balanceof payments was in a comfortable position, especially during the latter halfof the decade, owing to improved terms of trade. The CPI growth rate was lessthan 5% per year on average during the latter half of the 1970s, and thecurrent 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% in1979. The domestic investment ratio, though high, was lower than the domesticsaving ratio. However, Malaysia had a chronic fiscal deficit of about 6-7% ofGDP during the 1970s. The deficit was financed domestically through the issueof Government securities to institutions other than banks (Table 5) to financelarge development expenditures and subsidized public enterprises.

2.7 Financial institutions in Malaysia operated under more competitiveconditions than those of Korea. The share of commercial banks in total assetsof the financial system was about 40%, while the shares of NBFIs and theCentral Bank were about 10% and 20%, respectively; the remainder was shared byprovident, pension and insurance funds, savings institutions and developmentfinance institutions (DFIs) (Appendix Table Malaysia 4). Domestic banksbecame active, and by the end of the decade they accounted for one third ofthe total financial assets of banks. Three government-supported banks claimedas much as 80% of total deposits and 74% of loans of domestic banks (S. Leeand Y. Jao, 1982). The operations and management of commercial banks(including the government-owned commercial banks) were largely autonomous, andthere was considerable freedom of entry of new banks and branch expansion.Malaysia had a relatively large securities market compared to those of otherdeveloping countries in the 1970s. However, the public sector dominated thenet 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% in1977-1979) 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 tothe 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 thatthe NBFIs kept pace with t:he banks (Appendix Table Malaysia 2). Compared tothe other four Asian countries under discuLssion, Malaysia's financial sectorwas 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 ofcommercial banks, but this did not adversely affect the level of interest ratein real terms owing to the low inflation rate (CPI); the average annual realdeposit rate was about 3% during 1975-1979 and compared favorably with realdeposit rates in industrialized countries such as Japan, Germany and the USduring 1950-60. Malaysia also had selective credit programs since 1976 aspart of a new economic policy to support small-scale enterprises. This creditwas estimated at 30% of total bank credit; the subsidy involved, however, wassmall.

2.9 The liberalization of interest rates in Malaysia was a logicalconsequence of the development of a wide range of interlinked financialintermediaries. These made use of new financial instruments and rendered theadministered interest rate system much less effective than before. Unlike therates in Korea, the real interest rates were not low in Malaysia despiteinterest rate controls. Foreign factors had major influence in determiningdomestic interest rates. Interest rate controls were retained mainly toensure the stability of domestic interest rates in an environment of an opencapital account and a floating exchange rate regime and to promote theindigenous banks by limiting price competition with dominant foreign banks.Thus, financial liberalization did not have the same significance as in othercountries.

The Philippines

2.10 The Philippine economy in the 1970s was relatively stable, with acomfortable rate of growth between 6% and 6.5% per year. Gross domesticinvestment as a ratio of GDP rose from 25.1% in 1974 to 29.0% in 1975, and thegross domestic saving ratio rose from 22.0% in 1970 to 22.7% in the sameperiod (Table 10-I and II). The Philippines had a chronic deficit on thecurrent account of its balance of payments of around 5% of GNP during1974-1980, although the nontraditional export sector grew impressively. Majorexternal shocks affected the Philippines and other oil-importing developingcountries during the turbulent period of 1970s. The first oil shock in 1974caused the domestic inflation rate to jump to 34.2%. The inflation rate waskept below 10% until the second oil shock of 1980, when it escalated to 18%(Table 1). The fiscal deficit remained modest during the 1970s, fluctuatingaround 1.0% of GDP. There was no major macroeconomic imbalance in thePhilippines until the late 1970s and the early 1980s when financial reform wasintroduced. However, thet current account of the balance of payments remainedin 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 offinancial institutions was not severely restricted until 1970; since then, andfollowing the recommendations of the joint IMF/CBP Banking Survey Commissionof 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 4120KOREA - - - - - - - - 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 76.2SRI 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. Thenonbanking pact of the Philippine financial system expanded in the 1970s,mainly due to the expansion of money market activities and a wide variety ofnew services offered by the nonbank financial intermediaries (Appendix TablePhilippines 2).

2.12 The growth of the financial sector (comprising commercial banks,small rural unit banks, savings banks, development banks, savings and loanassociations, finance companies, investment institutions and pawnbrokers) wassteady during the 1970s. The M2/GNP ratio grew from 16.8% in 1974 to 21.0% in1980 (Appendix Table Philippines 3). By the mid-70s, money market developmentaccelerated and attracted substantial financial savings. The Philippines hada long tradition of antiusury laws. During the period 1974-1980, the MonetaryBoard prescribed maximum deposit and lending rates. Although the rates wereoften adjusted to reflect market conditions, nominal interest rates were infact fixed below market rates and were mostly negative in real terms. Theinterest rate structure did not display a normal yield curve. The differen-tials between short- and long-term rates did not encourage term transformationof maturities by the commercial banks. However, interest rates in the moneymarket (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 involvedbanks in losses. In addition to the directed credit programs, the Governmentinfluenced the allocation of credit of two major government-owned banks, thePhilippine National Bank (PNB) and the Development Bank of the Philippines(DBP).

2.13 There was since early 1970 an awareness in the Philippines of theinevitability of some liberalization, particularly regarding the need toreduce the irksomeness of interest rate controls. This awareness wasstrengthened by the growing need towards the end of the 1970s to raise long-term finance, the unavailability of which was traced to the restrictiveinterest rate policy. Under the interest rate ceiling, the real return onbank deposits and loans fluctuated with the inflation rate. This preventeddepositors from choosing longer maturities for their assets and banks fromengaging in long-term credit contracts. Meanwhile, the money market, dealingwith short-term finance to the industrial sector, tended to appropriate agrowing share of bank deposits since it was free from interest rate controls.Against this background, the IMF-World Bank Study (1979) outlined the contoursof financial reform, the main elements of which were: (a) liberalization ofthe interest rates; and (b) introduction of a "universal" banking system toreduce fragmentation of financial intermediation and encourage broader accessto financial resources for meeting long- and medium-term credit needs. Thecommercial banks circumvented the interest rate ceiling by raising fees andother charges to the borrower, and the growth of the money market was notaffected by interest rate controls. Recognizing that interest rate controlwas not only inefficient but also ineffective, the Philippine authoritiesabolished 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 oilrevenues and large amounts of foreign aid. The rate of domestic investmentaveraged 27.6% of GDP during, 1973-83, and the gross domestic saving ratioaveraged 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 capitalaccount, and residents enjoyed freedom to borrow in foreign markets.

2.15 Indonesia began to experience serious problems when the oil priceboom abated in the early 1980s. This was reflected largely in the deteriora-tion in the external payments position, with the GoverDnment's fiscal deficitreaching 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 the20% rate which prevailed during the 1970s. The decline in oil revenues andthe consequent worsening of the balance of payments put pressure on theresources of the Government and the private sector. The mobilization ofdomestic resources thus became a matter of great urgency.

2.16 On the eve of financial reform in 1982, the Indonesian financialsystem had considerable depth as well as breadth. In addition to the Bank ofIndonesia, it consisted of deposit money banks (DMBs) which included state-owned banks, development banks, insurance companies, savings banks, and creditinstitutions of all types. The relative importance of NBFIs for the financialmarkets was limited: their total financial assets amounted to barely 7%(Appendix Table Indonesia 6).

2.17 An elaborate system of regulations governed Indonesia's financialsystem before 1983. The financial sector was left untouched by an earlierwave of economic liberalization in 1977. First of all, there were ceilings onthe interest rates on deposits and loans of 8 state banks which accounted foralmost 40% of total gross financial assets in Indonesia until 1983; privatecommercial banks and foreign banks were excluded from regulation. The distor-tion in the pattern of interest rates was a consequence of the restrictions oninterest rates paid by the state banks. These restrictions rendered the rateof return on the major part of financial savings negative and increased thegap between interest rates paid by the state banks and nonstate banks(Appendix Table Indonesia 2). Second, there were credit ceilings onindividual 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 systemof liquidity credits which were given at subsidized interest rates to banks torefinance low-interest-rate loans to priority sectors. Refinancing wasautomatic, but the subsidized rates and the proportions of refinanced creditsvaried 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. Theserepressive financial measures had a dampening impact on Indonesia's financial.system. The ratio of M3 to GNP hovered around 18% during 1975-83 (AppendixTable Indonesia 4) despite rapid economic strides made by raising saving andinvestment through expanding oil revenues.

17

2.19 The motivation for initiating the financial reform in Indonesia wasto mobilize domestic resources to finance investment. The spurt in domesticsavings, which was largely attributed to the growing oil revenues, facilitatedthe financial system's growth in terms of assets and other financial services.However, the saving arising from the oil revenue was mainly government savingand, this being the case, it slackened when oil prices declined as they didfrom the beginning of the 1980s. This decline also affected adversely theforeign 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 indicatorthan 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 ofpayments remained precarious, even with stringent exchange and trade controls(D. Khatkhate, 1983). In fact, all the macroeconomic imbalances--fiscaldeficit, excessive monetary expansion, inflationary pressures anddeterioration in the balance of payments--were traceable to the elaborategovernment-directed machinery which allocated foreign exchange and regulatedinvestment and consumption.

2.21 Sri Lanka had, in 1977, a fairly modern type of financial marketswith a variegated institutional pattern; the commercial banks' share of totalfinancial assets was 35%. Sri Lanka had three major state-owned banks--one acommercial bank, the Bank of Ceylon, and the National Savings Bank, thePeople's Bank, the main vehicle to mobilize savings. Other commercial banksand development banks together with insurance companies were operating, buttheir assets as a proportion of total financial assets were small. There waslittle competition because the government-owned banks were dominant (AppendixTable Sri Lanka 7).

2.22 The financial system of Sri Lanka was financially repressed, withnegative real interest rates and relatively slow expansion of financialassets, as reflected in their low ratio to GDP. The nominal rates were in therange of 7-7.5% on one-year time deposits mostly held by the two state-ownedbanks. Bank lending rates were higher than deposit rates, ranging between9.5% and 14%, and, in the context of the prevailing inflation rate, they werenegative in real terms. Most credit to priority sectors was subsidizedthrough selective credit policies. The subsidy was financed by the CentralBank through the liberal and unrestricted accommodation the banks enjoyed,with the latter at a concessional refinance rate. The growth rate of thefinancial system declined sharply during 1968-75 compared to 1961-67. Thegrowth 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 wasalso 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 wastaking 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 newGovernment's intention was to give free reign to the private sector and marketforces 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 reformpolicies 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 countriesunder discussion initiatedi financial reform policies.

Korea

3.2 Financial reform in Korea was gradual. In 1981, the Government beganto privatize the nationwide commercial banks by divesting its shareholding; by1983, it had privatized aLl nationwide city banks. Furthermore, the Govern-ment revised the General Banking Act toward the end of 1982 to give banks afreer hand in dealing with their own affairs by formally abolishing variousregulations on the operation and management of banks. However, it maintainedde facto monitoring of bank management ani credit allocation. One of themajor reasons for this was that timing of the reform coincided with the onsetof 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 citybanks were allowed to be established. But the real beneficiary of the relaxa-tion of entry barriers was the nonbank financial sector. The number ofinvestment and finance companies increased from 20 in 1980 to 32 in !982, andthe number of savings and finance companies from 191 to 249 in the sameperiod. The entry of foreign banks was also relaxed. Sixteen foreign bankswere allowed to open business during 1981-1984, bringing their total number to49. The primary purpose of permitting entry of foreign banks was to encourageforeign capital inflows; it was also felt that foreign banks would motivatedomestic banks to improve the quality of their service and operation throughcompetition 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 developmentof short- and long-term financial markets and to enhance the capacity of thefinancial institutions as mobilizers of savings. Some of the new.instrumentswere used by more than one type of financial institution to encourage thecompetition among them.

3.5 The interest rate ceilings were adjusted upward in 1979 to yieldpositive real interest rates, although this intent was frustrated by highinflation 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 allpreferential 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 wasintroduced to reflect the differential in creditworthiness of borrowers andthe maturity of loans. However, the Korean Government still maintained theinterest rate ceilings except in special markets such as the interbank,unguaranteed commercial bills and corporate bond markets. It is noteworthythat no significant steps were taken to liberalize external capital flowexcept 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 inOctober 1978. Commercial banks were allowed to determine their own interestrates on deposits and loans. However, the prime rate was controlled by themonetary authority during 1978-1981. Late in 1981, a new interest rate mech-anism based on the base lending rate (BLR) was introduced, signalling avirtual disappearance of the last vestiges of control on lending rates.Accordingly, the commercial banks began to shift away from the use of theprime rate. They pegged their lending rates to their own BLR based on theircost of funds after provisions for the cost of holding cash, statutoryreserves, liquid assets requirements and overhead. The margin charged on eachloan was based on the customer's credit standing, the nature of the project tobe financed, the repayment schedule and the security offered. From Novem-ber 1, 1983, all interest rates on loans and advances other than thoseprescribed by maximum ceiling rates and the law were linked to the BLRs of therespective banks.

3.8 However, the Central Bank of Malaysia continued to impose a ceilingon the lending rates for three special categories of borrowers: theBumiputera community for loans not exceeding M$500,000 each, small-scaleenterprises where the loans did not exceed M$250,000 each, and housing loanswhere the cost of land and house did not exceed M$100,000 each, compared withM$200,000 previously. For small loans, the Special Loan Scheme was introducedin January 1981.

3.9 When the new economic policy was initiated, no significant steps weretaken to alter the selective credit programs in existence in Malaysia since1975. On the contrary, directed credit programs seem to have increased forvarious sociopolitical reasons since mid-1970. Malaysia has had an opencapital market since the 1960s.

The PhilipRines

3.10 In the Philippines, the banking laws were amended in March 1980 topermit the adoption of a universal banking system patterned on the Germanmodel. To facilitate the change, the ceilings on various categories of banklending and deposit rates were first relaxed and then removed. The interestrates on the long-term loans and deposits were removed first in order toencourage term lending; later, the interest rates on short-term deposits wereremoved. The last deposit rate ceiling (or deposit with maturity of two yearsor less) was eliminated in mid-1984, and the last lending ceilings on short-term loans were eliminated in January 1983. However, the interest ratesubsidy for preferential credit programs was continued. It was not until 1985that the Central Bank finally eliminated the subsidy element by aligning therate of rediscounting of preferential loans to the market rate.

20

3.11 Under the amended banking law, commercial banks which achieved acapital level of P 500 miLllion could apply to the Central Bank of thePhilippines (CBP) to become "unibanks" and, upon approval, were authorized toexpand their activities to include near-banking activities such as those asso-ciated with investment houses, leasing companies and finance companies thathad not previously been open to commercial banks. Nine commercial banks wereconverted to unibanks initially, but later one of them stopped functioning.Unibanks were also permitted to make equity investments in allied andnonallied enterprises and were authorized to issue credit guarantees. Therewas 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 ratiofor banks capitalized at less than P 500 million, an 8% ratio for bankscapitalized at P 500 million but less than P 700 million. and a 6% ratio forbanks capitalized at P 700 million or more, effectively increasing the lendingceilings for unibanks. Thrift banks, which comprise savings and loanassociations, mortgage banks and the private development banks, were permittedto provide full domestic commercial banking services including (with prior CEPauthorization based on the applicant thrift bank's good standing) acceptanceof demand deposits.

3.12 Banks that became unibanks were required to broaden their ownershipbase so that no one family or business group could retain control. No singledomestic owner or group of owners within 3 levels of consanguinity werepermitted to have more than 20% of the voting stock, and ownership by foreigninterests was limited to 40%. Ownership concentrations that existed prior tothe enactment of the new laws could continue until reduced voluntarily butcould 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 ofthe private commercial banks were still closely allied with one or more of theleading families.

3.13 There was no further relaxation of entry barriers to the bankingsystem. On the contrary, the minimum capital requirement for commercial bankswas 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 beentaken on the capital flows. The capital account had been quite open in thePhilippines despite formal restrictions on foreign exchange.

Indonesia

3.14 Indonesia's financial reform was far-reaching in both content andcoverage. The reform was implemented in two stages, the first in June 1983and the second in 1984. The June 1983 reform had three principal parts:(a) elimination of ceilings on bank credits; (b) gradual narrowing of loancategories from access to Bank Indonesia (BI) liquidity credits; and(c) deregulation of state banks' interest: rates on most categories of depositsand 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 calledServifikats Bank Indonesia (SBI); and (b) the introduction of new money-marketinstruments, Surat Berharga Pasar Uang (SBPU), in February 1985 (T. Balino andV. Sundararajan 1984; V. Sundararajan and L. Molho 1986). The second phase of

21

reform called for creation of new instruments to absorb the excess liquidityof 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 ofimposing reserve requirements.

3.15 The elimination of credit ceilings facilitated a switch to indirectregulation of credit through reserve money management. This switch, and itsconsequent impact on the functioning of the money market, oriented the bankingsystem to manage its loan portfolio on the basis of cost-benefit criteria. Asa result, competitive forces were given greater leeway. The elimination ofceilings on interest rates which were applicable only to the state banks--thedominant institutions in the banking system--was necessitated by the need tomake 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 thestate banks on liquidity credits, the size of which was determined more bydemand, was expected to decline.

Sri Lanka

3.16 The main accent of Sri Lanka's financial reform was on the removal ofrestrictions on interest rates. This was done first by raising the bank ratefrom 8.5% to 10% p.a., thereby giving a signal to other market rates ofinterest. This was followed by raising sharply the interest rates on depositsof the National Savings Bank (NSB), the most dominant mobilizer of financialsavings. In fact, deposit rates paid by this bank were announced to be thekey rates for other banks and the financial institutions to follow. At thesame time, the basic exchange rate and the premium value (FEEC) were firstunified at an initial rate of SLR 16 to the US dollar, and then the exchangerate was allowed to float. The depreciated exchange rate and the increaseddomestic interest rates ensured that the illicit outflow of financial assetswould decline and the domestic financial intermediation process would bestrengthened.

3.17 The higher level of interest rates by itself would not have resultedin 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 ofSeptember 30, 1977. This limit which was subsequently raised to 7%, andborrowing over the limit was charged a penalty rate of 15%. The selectivecontrol policy, however, was continued, although it was made even more selec-tive, and the concessional element in interest rates was scaled down. Bankswere 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 ithad assumed in the past were market determined. What was important, there-fore, was not the dimensions of the financial reform but the break it markedfrom the dirigistic traditions of previous Sri Lanka policy makers. Thereforms of 1977 carried the interest rates to a level at which depositorsfound it rewarding to hold wealth in financial assets, and borrowers could usescarce 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 otherdeposit-taking nonbanks, could freely enter the field. This was evident fromthe subsequent establishnent: of the foreLgn currency banking units (FCBUS)which could transact in foreign currency with nonresident enterprises in thefree trade zone and accept foreign currency deposits from nonresidents.

3.19 Exchange controls were considerably diluted. Measures for decontroLof prices and allocation of credit through interest rates were introduced whenthe budget was presented to the parliament. This matching liberalization inother sectors of the economy reflected favorably on the financial sector andcontributed 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 notonly on the principal elements constituting the reforms and their modusoperandi but also on how these reforms interact with the macroeconomicpolicies of the countries concerned. The financial reforms by themselves maybe well designed and sound, but they may fail to accomplish what they wereintended to accomplish if macroeconomic policies are not in tune with them orif they cause undesirable changes in the real economy. It is thereforeessential to view the consequences of financial reforms in the context of themacroeconomic environment.

Macroeconomic Environment

Korea

4.2 From this perspective, changes in the macroeconomic environment since1980-82 contributed greatly to the achievements of financial liberalization.Korea's terms of trade have improved significantly since 1980, substantiallymore than other countries in this study except Sri Lanka (Table 6). Inflationhas been very stable and low since 1982; the real effective exchange rate wasrelatively stable until 1985 since when it appreciated. The current accountdeficit gradually declined from its peak in 1980-1982 and turned into a large''surplus by 1986 (Table 3). This encouraging macroeconomic environment wasbrought about partly by external factors such as declining commodity pricesand 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 largelyflexible in response to changes in the financial and real sectors. As of1987, the Korean economy remains one of the fastest growing, and it has greatmacroeconomic stability (see V. Corbo and S. Suh, 1988).

4.3 With such a happy conjuncture of circumstances, the financialliberalization policy took hold. In consequence, the earlier pattern offinancial segmentation changed perceptibly, and a sharp drop in the inflationrate helped convert the interest rates of banks and NBFIs from negative tosignificantly positive levels in real terms. As a result, the financialsystem as a whole recorded dramatic growth in the first half of the 1980s.The focal point of growth was the nonbank financial intermediaries such asinvestment and insurance companies and direct markets for corporate bonds andcommercial bills. These institutions were not much constrained as to the sizeor allocation of their funds to particular industries and were either freefrom or able to circumvent interest rate ceilings on both sources and uses offunds. They were the real beneficiaries of reform insofar as they couldattract, unhindered, a large amount of financial savings. In contrast, thecommercial banking segment of the financial system could not derive as muchadvantage from financial reform because it was constrained by the restrictivemonetary 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 1986II.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 10.60NALATSIA - - - - - 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 17.53SRI 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 thereoccurred a fair degree of integration of the financial markets; theunregulated markets were brought in closer alignment with the organized creditmarkets; the cost of intermediation fell and the availability of term creditfrom NBFIs and direct financing increased. Against these favorable effects ofliberalization, the banks were confronted with a large and potentiallydisruptive volume of nonperforming loans, which increased partly because ofthe liberalization policies and partly because of past excessive governmentintervention and external shocks during the reform period.

Malaysia

4.5 After financial reform, Malaysia's economy faced a sharpdeterioration in the terms of trade. Its national income fell in 1979 by4.5%, and a sizeable deficit in its current account of the balance of paymentsemerged (Table 3). The Government's initial response was a countercyclicalpolicy directed towards aggressive expansion of public investment in bothinfrastructure and directly productive activities. This soon becamefinancially unsustainable as large deficits emerged in both the externalcurrent and fiscal accounts. The scale of fiscal expansion in 1981 and 1982was unprecedented and resulted in an increase in the government deficit to19.7% and 18.7% of GNP in 1981 and 1982, respectively; the current accountdeficit reached 10% and 13.4% of GDP in the same years. Since 1983, theGovernment has tried to cut its expenditures drastically. The cuts coincidedwith a slowdown in private investment: overall, investment declined, and withit, the economic growth rate. Gross domestic investment as a ratio of GNPslipped from 39.1% in 1982 to 27.8% in 1986, narrowing the current accountdeficit to 1% of GDP. Due to all these adjustment efforts, Malaysiaexperienced negative growth (-1.1%) in 1985 and grew by only 1% in real termsin 1986.

4.6 Despite the disc:ouraging macroec:onomic environment, the financialsector in Malaysia developed rapidly, owing to the increased real interestrates ensured by liberalization of interest rates and sustained pricestability. The extent of the rise in nominal bank deposit and lending ratesremained modest, reflecting initial conditions which themselves werenonconstraining, but their level in real term was substantially high due tofurther deceleration in the inflation rate since 1984. There was someprogress towards integration of domestic interest rates, mainly on the depositside, but the gap in lending rates charged by different groups of financialinstitutions widened to some extent. When small-sized banks could appropriatea growing share of the credit market, the spread between deposit and lendingrates increased, indicating the persistence of a strong oligopolistic elementin the banking structure; long-term funds became more ample than before. Thebanking system faced a problem of nonperforming loans. Since 1985, when theeconomy was in deep recession and there was a collapse of the real estatemarket (to which the banking system had large exposure), it weathered thestorm more skillfully. In Malaysia's case, the macroeconomic policiesappeared to have been as helpful as the liberalization policies in thefinancial deepening process.

27

The PhiliRRines

4.7 The Philippine economy was considerably weakened by the second oilshock of 1979. It experienced a major macroeconomic imbalance starting inOctober 1983. The economy contracted, mainly because of the inability of thePhilippines to continue to borrow abroad to finance its current accountbalance of payment deficits. Since the late 1970s, the Government has pursuedcountercyclical expansionary policies to sustain high economic growth againstthe 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 inthe Philippine economy combined with the political events of autumn 1983propelled a large outflow of funds and withdrawal of suppliers' credits. As aresult, the Government introduced a rationing system for foreign exchange anda moratorium on capital repayments abroad. The practical consequence of theseevents was that for the next two years the economy could not obtain foreignresources. There was a current account deficit of 7.96% of GDP in 1983, and areduction in the gap in international payments could be achieved only by asharp reduction in imports. With real consumption spending unchanged, therewas a sharp decline in capital formation.

4.8 The process of adjustment over 1983 and 1984 involved a largedevaluation of the peso, which together with a large fiscal deficitcontributed to the;escalation of the inflation rate from 19% in 1983 to 50% in1984. In order to counter inflation, an aggressive policy of monetarycontraction was followed in 1984; this took the form, among others, of thesale of new, high-yield instruments by the Central Bank. A modest resumptionof external funding and a reversal of capital flight facilitated economicrecovery beginning in 1986.

4.9 During the initial years of financial liberalization, 1981-83,developments in the financial sector showed promising movement toward theintended goals of liberalization. Nominal interest rates were adjustedupward, though not substantially. However, real interest rates were positive,in the range of 3-5%, mainly because of deceleration in inflation immediatelyafter the reforms. After 1984, the rise in nominal interest rates induced bythe issue of high-yield instruments reached 39-44%, up from 14-15% in previousyears. This coincided with monetary contraction and led to a decline ininflation. The growth of the financial sector was impressive by the standardsof earlier years (1977-80) when the ratio of financial assets to GNP remainedalmost constant.

4.10 With high nominal and real interest rates after 1984, the highlyleveraged corporate borrowing sector was enmeshed in financial difficultiesbecause of its distress borrowing. The arrearage rate of banks, particularlythe government bank, rose sharply to 30-90% of total assets, and the CentralBank had to intervene to bail out several of them. As a result, in 1980-86the banking system experienced a contraction of real assets to the tune of44%.

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 afterreform but declined equalLy sharply to 1.9% in 1985 (Table 2). Of course, theexternal shock of a rapid decline of 15% in the terms of trade from 1983-1986was the principal reason (Table 6). Desp:Lte the depreciation in the rupiah'sreal effective exchange rate, the current account deficit in the balance ofpayments, though half what it was in 1983, was still large enough to reversethe market's expectations of further rupiah devaluation. This was notsurprising, 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, whichwas halved from 12% in 1983 to 6% in 1986. The total domestic savings raterose 2.5 percentage points in 1984 to 32.1% but fell to 25.5% in 1986, lowerthan in the first year of financial reform. Total investment declined evenmore 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 moresignificant was the fact that both public and private investment declined, asdid public and private-sector savings.

4.12 The consequences of financial reform in Indonesia seemed to befavorable when judged by growth in M3, competitiveness of the state banks, andthe attairunent of positive real interest rates during most of the period. TheM2/GNP ratio rose sharply from 20.9% in 1984 to 29.4% in 1986 (Appendix TableIndonesia 4). The deposit rates of all categories of banks remained not onlypositive but very high in real terms (Appendix Table Indonesia 2). Since thestate banks were given considerable latitude in regard to fixing interestrates, competition among banks became more intense and boosted the efficiencyof the banking system as a whole. Though domestic interest rates were wellintegrated with foreign interest rates, the influence of foreign factors ondomestic interest rates became stronger, somewhat to the detriment of domesticinvestment. The introduction of new financial instruments like the SertificatBank Indonesia (SBI) and Surat Berhanga Pasar Uang (SBPU) imparted strength,vigor and competitiveness to the money markets. In addition, the range ofnoncredit 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 thehighest at 7% and thereafter averaged about 5.5% until 1985, not substantiallydifferent from the average growth rate during 1975-77. Total investment as aproportion of GDP increased sharply from 16% on the eve of financial reform to28% during 1978-85; domestic saving, however, was around 15.5% during the sameperiod. The rate of inflation as measured by the GDP deflator declinedinitially but increased subsequently to 14%, more or less the same level as in1975-77. The fiscal deficit remained unaffected during 1978-79, increasedsharply to 23.0% of GDP in 1980 and hovered around 13% until 1985. Thebalance 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 ofGDP 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 systemwere impressive. Both the M2/GDP and M3/GDP ratios recorded a rise, thelatter increasing from 40% in 1977 to almost 50% in 1985. Both deposit ratesand lending rates turned positive except during 1980 and 1984. Thoughinterest rates were determined through regulation, market considerations weregiven due weight. The most conspicuous achievement was in regard to enhancedcompetitiveness among banks because of an increase in the number of domesticbanking units and offshore foreign banking units (FCBUs).

4.15 The Consequences of Financial Liberalization. The consequences ofliberalization for the financial systems in the five countries are discussedin greater detail at a disaggregated level. The areas chosen fordisaggregation are: (a) the level and structure of interest rates; (b) growthof the financial sector; (c) competitiveness, profitability and efficiency offinancial institutions; (d) availability of long-term credit; (e) integrationof domestic interest rates with foreign interest rates; (f) quality of banks'loan portfolios; and (g) the corporate sector's financial structure. Theconsequences 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 consistentlynegative in real terms throughout the 1974-80 period, turned increasinglypositive after the 1981 financial reform (Appendix Table Korea 3 andChart K1). Thus real bank deposit rates reached about 5-7% and real bank loanrates about 7-10%, during 1982-1986. The positive real interest rates stemmedmainly from a decline in the inflation rate, but unlike the case during the1970s, equally important was the Government's commitment to maintaining apositive real interest rate, made clear by its constant watch over movementsof inflation rates in order to adjust bank interest rates. A distinguishingfeature of Korea's interest rate policy was that it remained market orientedalthough the Government continued to intervene in determination of interestrates. This approach was, however, pragmatic, as borne out by the fact thatthe nominal deposit and loan rates were adjusted downward frequently in 1982(in the face of persistently high inflation expectations), because it was feltat the time that many corporate firms had difficulties meeting their debtrepayment obligations and it was necessary not to aggravate the arrearageproblem. Although this induced some shift in deposits away from banks toNBFIs, it contributed substantially to the reduction of the corporate debtburden while keeping real interest rates substantially positive. If theGovernment had not readily adjusted the lending and deposit rates wheninflation started to decelerate, there might have been more massivebankruptcies of the corporate firms, and the problem of the banks'nonperforming loans might have become more acute. The Korean experience inregard to a timely adjustment in interest rates (see Appendix Korea, Chart Kl)through government intervention may be seen in contrast to events in thePhilippines in 1986 and in Malaysia in the 1980s, where market-determinedinterest rates lagged behind the decline in the inflation rate. This issuewill 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 eliminatelow preferential bank loan rates for priority activities such as exports.This was accomplished primarily by curtailing the number of such loans andlowering general loan interest rates in consonance with a fall in theinflation rate to the prevailing level of preferential loan rates (AppendixTable Korea 4). Since 1986, Korea has begun to phase out even thepreferential export credit, especially to large firms, as the current accountof the balance of payments began to record large surpWuses. With slow butsteady attenuation of government intervention and positive interest rates inthe organized markets, the unregulated markets have been brought in closeralignment 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 creditmarket 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 wasdetermined by the Government, There was not, however, significant movementtoward a normal term structure of interest rates except that the range of thelending rates widened slightly.

Malaysia

4.19 Two features of Malaysia's experience with interest rateliberalization stand out. FiLrst, while nominal interest rates increasedslightly, real interest rates increased substantially because of pricestability, and second, real rates were very sensitive to the liquiditysituation of banks and to monetary policy. The impact of liberalization ondomestic interest rates in Malaysia was modest at the beginning, despite thefact that international interest rates adjusted for exchange rate changes wererising sharply. The moderate movements of the deposit and lending ratesreflected in part the initial conditions preceding liberalization, which gavea greater play to market forces, and to some extent also the policy of theCentral Bank to control the prime rate. Even before 1978, when bank depositrates were subject to ceilings, the lending rates were subject only to a floorset by the prime rate. As a result, banks were able to charge higher rates tononprime borrowers depending upon demand conditions; this caused the averagelending rate to remain about two percentage points above the prime rate in thethree 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 perceptibleinfluence on lending rates and resulted in only a slight upward adjustment inthe deposit rates of individual banks.

4.20 The control of the prime rate and hence of the lending rate structuresof the larger banks, whose share of loans to prime borrowers was substantial,not only prevented the full extent of downward adjustment in the deposit rateswarranted by the surplus 'banlc liquidity, but also changed the structure of thebanking industry. Since late 1980, bank liquidity has come under increasingpressure from rising international interest rates and the gradual upsurge indomestic credit demand. 'Under these circumstances, many small banks, whoseshare of lending to prime customers (the Government and public enterprises)was not large, found it attractive to raise deposit rates and lend to nonprimeborrowers at rates that ensured profits. This in turn put upward pressure onthe 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 rosesteadily and were above the prime rate during most of this period. Reflectingthese developments, the share in total deposits of the five largest banksdeclined sharply during 1978-81, while the share of small banks showed acorresponding increase (Appendix Table Malaysia 6).

4.21 The introduction in late 1981 of the new interest rate mechanismbased on the base lending rate (BLR) marked the beginning of a new phase inthe liberalization process and was a response to the pressures discussedabove. Overall, the average level of real deposit and lending interest rateswas substantially higher after liberalization, especially during 1982-1986,compared to the period before liberalization. Thus, during 1982-86 theaverage lending rate in real terms was above 10-12% annually in commercialbanks and 10-14% in finance companies (Appendix Table Malaysia 5). The loanto deposit ratio of the banking system rose from 86.8% in 1980 to a peak of94.0% in 1985 (Appendix Table Malaysia 8) and continued its upward march inthe next two years, due in part to large loan commitments by banks to propertyand the corporate sector (in view of its serious cash-flow problems). Since1987, interest rates have fallen very rapidly following the easing of bankliquidity, a combined result of lowering liquidity requirements, an increasein private financial savings and low demand for credit due to economicrecession.

4.22 There was some progress in Malaysia toward the integration of thevarious domestic interest rates, mainly on the deposit side. The 12-monthdeposit rate of banks was about 1-1.5% lower than the 12-month deposit rate offinance companies during 1978-1980 when the prime rate of banks wascontrolled. This gap narrowed to 0.5-0.75% in recent years (Appendix MalaysiaChart Ml). With an increase in the interest rate sensitivity of depositorsfollowing the liberalization, and with growing public confidence in financecompanies, deposits with finance companies became closer substitutes for bankdeposits. However, the gap between commercial bank lending rates and financecompany rates has widened recently (Appendix Malaysia Chart M2), presumablydue to the higher risks of borrowers from finance companies, which deal withconsumer and housing loans.

4.23 However the segmentation of interest rates between banks and financecompany's assets and liabilities and government securities and treasury billsremains immune from the impact of liberalization because the governmentsecurities were sold in a captive market, to commercial banks, which used themto fulfill liquidity requirements.

4.24 Compared to the period prior to interest rate liberalization, theterm structure of deposit rates became flatter, perhaps the result of theremoval of the maximum rate ceiling on short-term deposits. Data on the termstructure of lending rates charged by commercial banks are not published.However, trends in the merchant bank lending rates by maturity indicate thatthere were no significant changes in the term structure of interest ratesafter liberalization, probably traceable to the stable inflation rateprevailing in Malaysia. Another reason was that there was no basic change inloan rates: before liberalization, only the minimum lending rate wascontrolled, so banks could charge different rates for different maturities ofloans.

- 38 -

TABLE 12: PERFORMANCE OF ILANKS

1.INDONESIA: INCOME, EXPENDITURES AND PROFITS OF TOTAL BANKING SYSTEM(CONTINUED)

(AS % OF TOTAL ASSETS)

ESTIMATED1982 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 ASSETSSOURCE: FEDERATION OF KOREAN BANKS, THE ANALYSIS OF THE EFFICIENCY OFBANKING 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 ASSETSINTEREST MARGIN 2.40 1.82 2.11 3.40 2.19 2.20 2.33EARNING MARGIN 3.24 2.52 2.88 4.25 2.90 2.94 2.88OPERATING COSTS 1.25 1.15 1.19 1.37 1I97 0.96 0.99PERSONAL EXPENSES 1.07 0.95 0.97 0.92 0.85 0.78 0.77NET INCOMES 1.99 1.37 1.70 2.88 1.83 1.98 1.89DEPRECIATION AND PROVISIONFOR BAD DEBTS 0.26 0.23 0.23 0.35 0.31 0.43 0.36GROSS PROFITS 1.37 1.02 1.11 2.12 1.23 1.18 1.21NET PROFITS 1.24 0.83 0.91 1.89 1.02 0.84 0.86

AS A RATIO OF EARNING MARGIN oNONINTEREST INCOME 26.11 27.91 26.72 19.02 24.38 25.11 19.02OPERATING 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 1.491975 1.90 2.76 1.99 1.471980 1.90 2.02 1.16 1.081981 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 HALFSOURCE: 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 1INTEREST 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 TAXESAND 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 thenominal deposit and lending rates inched up only a little from 1981 to 1983(Appendix Table Philippines 5). However, a declining inflation rate meantthat real interest rates in fact increased substantially. Considering thatthe share of fee income in total operating income of banks between 1975 and1985 fell from 12% to 4% (implying that the banks were partly evading theinterest rate ceilings before 1981 liberalization), the effective interestrate to the borrower could have risen only marginally during the initial twoyears of liberalization (P. Honohan, 1988).

4.26 A spurt in interest rates began in 1984. To ensure a sharp monetarycontraction as required by an agreement with the IMF, the Central Bank issuedCB 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 forconversion into CB bills, which were high-yield, risk-free assets. Thecommercial banks inevitably were compelled to increase the deposit and lendingrates, but they did not fully match CB-bill rates. It is significant thatsince 1985 nominal interest rates have not fallen in step with the decline inthe rate of inflation and so yield very high real interest, reaching more than20% annually in 1985 and early 1986.

4.27 Domestic interest rates in the Philippines were relatively wellintegrated. Because of the market determination of most of the interestrates, borrower creditworthiness was graded by the difference in the interestrates charged. The exception to this was the government-directed creditprogram, the interest rate on which was controlled by the Central Bankrediscount rate until 1985; since then, however, a market-oriented unitarydiscount rate has been introduced by the Central Bank. These developmentssince liberalization may have contributed to the integration of the domesticinterest rates, though this could not be corroborated for want of relevantstatistics.

4.28 The term structure of interest rates in the Philippine widened afterderegulation (Appendix Table Philippines 6) and thereby facilitated thelengthening of the maturity of both deposits and loans (to be discussed laterin this section).

Indonesia

4.29 In Indonesia, the interest rates charged by the state banks (theceilings on which were removed) began to rise and, as a result the statebanks' competitive capacity was strengthened vis-a-vis that of private andforeign banks. Appendix Table Indonesia 2 shows the changes in variousinterest rates paid by banks. The state banks' deposit rates shot upimmediately to about 15% in September 1983 and brought their deposit ratesmore or less in line with those of foreign and other domestic banks. PariDassu, loan rates, too, increased. This increase had an impact on thelending 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 thecorresponding rates of the state banks.

44

4.30 A conspicuous feature of the interest rates in Indonesia in the wakeof liberalization was the very high level and volatility of real interestrates. These qualities are interrelated. There was downward rigidity in thereal interest rate level because market participants continued to expectdevaluation of the rupiah; this expectation tended to generate inflationaryexpectations. Nominal interest rates therefore remained high despite subduedinflationary pressure.

4.31 One of the offshoots of financial reform was the emergence of newmoney market instruments, SBIs and SBPUs, the former issued by Bank Indonesiaand the latter by the customers in connection with borrowing from banks ornonbank financial intermediaries, and also by banks and NBFIs in connectionwith interbank borrowing. As a result, the money market gained breadth anddepth and became a vehicle to reflect changes in market interest rates.However, interest rates on both SBIs and SBPUs were not entirely marketdetermined, despite the semblance of market influence seen in the weekly SBIauctions. The degree of integration of domestic interest rates in the wake ofliberalization increased between the deposit and loan rates of state banks andother banks, but rates on these new money market instruments, the interbankrate and the deposit and loan rates of commercial banks did not follow. Thislack of congruence among the various domestic rates had two causes. For onething, rates on the new money market instruments were contrived by the CentralBank and did not respond to market conditions. It was not surprising,therefore, that the rates on these instruments remained almost unchangedduring 1985-86 despite sharp movements in the banks' deposit rates (AppendixTable Indonesia 2). For another, interbank rates had always been below therates on SBIs and SBPUs, though the margin varied from time to time since late1984 because these rates were governed by the changing role of the interbankmarket as a source of funds to finance reserve requirements (V. Sundararajanand L. Molho, 1988). It could be mainta:Lned, however, that domestic interestrates in Indonesia were largely integrated after reform because bank assetsconstituted the overwhelming majority of total financial assets in Indonesia.

4.32 The term structure of interest rates in Indonesia displayed a (moreor 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 ofinterest rates, which increased risk on long-term deposits.

Sri Lanka

4.33 In Sri Lanka, the real interest rates on deposits--a minimum rate oncommercial banks' one-year deposits and the actual rate on similar deposits ofthe National Savings BarLk (NSB)--remained positive after 1977 except during1980 and 1984 (only for commercial banks) (Appendix Table Sri Lanka 10 andChart 1). Since 1977, though market considerations acquired importance withthe 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 marketdetermined. The guiding hand of the monetary authorities often signalledchanges in the interest rates charged by commercial banks and financecompanies. A major indicator of how the authorities intended the interestrates 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 FOREIGNEXCHANGE 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 COMMERCIALBANKS 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 FINANCIALINTERMEDIARIES 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(NATIONWIDECOMMERCIAL 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 FINANCIALINSTITUTIONS 23.7 31.8 46.6 48.9 41.8 16.3 25.2 44.1 47.3 45.6

DEVELOPMENTINSTITUTIONS 13.9 15.9 16.5 15.8 35.4 1.3 0.7 0.5 0.4 23.3 3

SAVINGSINSTITUTIONS 9.0 6.4 10.6 11.4 36.6 11.3 10.9 13.8 13.8 36.2

INVESTMENTCOMPANIES 0.1 8.7 14.6 15.8 74.7 - 10.1 21.9 23.8 94.1

LIFE INSURANCECOMPANIES 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 OFSECTOR 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 ANDINSURANCE 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 33.1COMMERCIAL BANKS 33.5 34.9 37.1 37.4 38.0 38.3 40.2 40.5 42.1FCBUs, NET OFFOREIGN LIBILITIES - - - 1.3 1.9 2.5 2.3 3.2 3.4NATIONAL SAVINGS BANK 9.1 8.9 9.2 7.8 7.1 8.3 8.7 9.2 9.8FINANCE 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 ANDINVESTMENT 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 1.0INSURANCE 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 UNITSDFCC: DEVELOPMENT FINANCE COMPANY OF CEYLON

50

the Central Bank's own securities and on government securities, fixed de factoby the Central Bank. Further, the Nation,al Savings Bank (NSB) fixed itsdeposit rates under the guidance of the authorities, as did also the otherstate-owned commercial banks. In practice, the treasury bill rate representedthe lower end of the range of what the authorities considered to be thedesirable level of intereist rates, and the rate paid by the NSB on itsdeposits was its upper erLd.

4.34 Detailed information on lending rates is not available, but it isbelieved that the weighted average cost of credit of commercial banks was12-14% in nominal terms and barely reached a positive level. This was becausethe state banks, with a large share in credit, and also the developmentfinance institutions (DFIs), often lent under the influence of the Governmentto the most risky and least profitable borrowers at low interest ratesdetermined by political criteria, thereby perpetuating distortions in thelending rate structure. However, the extent of this factor was limited sincesuch credit constituted only 5% of total domestic bank credit. Though theinterbank market has emerged and has operated actively (reflecting marketconditions to some extent), the rates prevailing in that market rarely havegone beyond the range which the authorities preferred. There was very littleinformation on the term structure of interest rates in Sri Lanka, but ingeneral the rates on deposits varied according to the maturity of deposits--3months to 24 months--and according to their size.

4.35 The abolition of ceilings on interest rates seems to have slightlynarrowed the differential in interest rates charged by different commercialbanks and nonbank financial intermediaries. The evidence, though not strong,throws some light on these aspects. At the end of 1985, the rate on 12-monthNSB deposits was 15% net of tax as against 12-13% on similar deposits ofcommercial banks; the deposit rates paid by finance companies were believed tobe even higher than NSB rates on corresponding deposits. As a result, themarket share of finance companies and NSB in total financial savings increasedsubstantially. Lending rates ranged from 15% per year for prime customers to30%, 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 veryrapid, stimulated as it was by the expanding proportion of private savingsgoing into holdings of f'inancial assets with high and stable real rates ofreturn (D. Kim, 1987). However, this growth was confined predominantly toNBFIs. As a consequence, the relative importance of banks declined, withtheir share in total financial assets going down from two thirds during the1970s to one half toward the end of 1986 (Appendix Table Korea 9). In recentyears, the informal market also seemed to decline in relative importance,although this cannot be quantified with precision. There was a moderateincrease in M2 and a near doubling of M3 as a ratio to GNP since 1981, aremarkable performance by any standard (Appendix Table Korea 8 and Chart K5).M3 included certificates of deposit and bank debentures as well as depositswith all NBFIs; therefore the difference betwean M2 and M3 is not a precisemeasure 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 ratioand again confirmed the important role of NBFIs in the growth of the regulatedfinancial system. Within the NBFIs, investment and finance companies were themost 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 termfunds in corporate bonds or in providing direct loans to business.

4.37 The markets for corporate bonds and commercial paper also grewrapidly in the 1980s. The growth of these markets was facilitated by severalfactors. First, the corporate bond and commercial paper markets were notsubjected to government price regulation. Interest rates on these financialassets were determined relatively freely, depending on the market situation,and were higher than the deposit rates of banks. Second, the tight control ofdomestic credit of the banking sector forced firms to take recourse to eitherthe direct credit market or NBFIs. Third, guarantees of corporate bonds bybanks reduced the risk and facilitated the growth of these assets. Theinstitutionalization of bond transactions on repurchase agreements in 1980also encouraged the rapid growth of a secondary market. Compared to bondissues, new stock issues were sluggish du,ring 1980-1985 despite governmentefforts to boost the market. However, it has boomed since 1986 in the wake ofexpanding exports and an economic boom. The market volume of listed stockexpanded very rapidly during 1986-88.

Malaysia

4.38 The growth of the financial sector in Malaysia since interest rateliberalization was quite impressive despite a low national saving rate in theearly 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 attractivereturn on bank deposits. The NBFIs, interest rates on whose assets andliabilities had been deregulated since 1973, also grew very rapidly during the1970s, and their growth accelerated in the 1980s. The ratio of M3/GNP (M3includes time and savings deposits of NBFIs) more than doubled from 47.5% in1973 to 82.3% by 1983 (Appendix Table Malaysia 2), attesting to a high degreeof financial deepening compared to other countries at a similar stage ofdevelopment (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 aresult, the M2/GNP ratio increased from 21% in 1980 to 25.3% in 1983, and theM3/GNP ratio rose from 25.6a; in 1980 to 29.8% in 1983 (Appendix TablePhilippines 3 and Chart P4). In view of a falling gross domestic saving rat:Loduring 1981-83, the increase of financial savings can be considered a goodachievement, Since 1984, however, growth of the financial system has beeninterrupted, and in fact it experienced negative growth in real terms, M2/GNPdeclined 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 thefinancial sector in this period can be explained largely by two factors.First, in the context of the adverse overall macroeconomic environment during1983-1986, the financial sector could not have expanded with a high inflationrate, devaluation of domestic currency, the failure of many financialinstitutions including banks and nonbanks, and the fall in domestic savingrate. Second, the aggressively contractionary monetary policy designed tocontain 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 bankdeposits, since the rate on bank deposits could not catch up with the T-billrate, even after a time lag, without jeopardizing the profitability of banks,Financial institutions lost resources. However, if T-bills and CB bills areadded to M3, the overall ratio of financial assets to GNP, i.e., M4/GNP, hasremained relatively stable since 1983 (P. Honohan, 1988; and Appendix TablePhilippines 3).

Indonesia

4.41 In Indonesia, financial reform had a substantial impact on financialsector growth from the outset. Gross assets of the organized financial sectorhave almost tripled since 1982--a growth rate of nearly 23% p.a. in nominalterms. The M2/GNP ratio shot up from 21.5% in 1983 to 29.4% in 1986 (AppendixTable Indonesia 4, 6-a, 6-6 and Chart I-4). In addition, the range ofnoncredit financial services widened with the establishment of several newinsurance and leasing companies. These increased, respectively, from 83 and34 in 1982 to 100 and 83 in 1987. Apart from this, new financial instrumentssuch as SBIs and SBPUs emerged and led to diversification of the menu offinancial assets. Furthermore, they helped erase regulation-inducedsegmentation in the loan markets.

Sri Lanka

4.42 In Sri Lanka, liberalization policies did not seem to influence thefinancial system in the desired direction. The M2/GNP ratio increased in 1986by only 2 percentage points, from 28.2% in 1977 to 29.3% in 1986. The sameheld true of the M3/GNP ratio, which included insurance funds (Appendix Table4 Sri Lanka and Chart 3). Segmentation in Sri Lanka's credit market was onecharacteristic 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 inthe 1980s, especially when commercial banks (after privatization) and NBFIsdirectly competed for new financial instruments. In addition, foreign bankswhose branches had expanded could compete with domestic banks more freely thanin the past. The profitability of commercial banks, which was always low andwas sustained by payment of interest by the Central Bank on the requiredreserves 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 competitionper se. Intermediation cost as represented by the spread between averagedeposit and lending rates may have narrowed on balance, though no definitiveconclusion can be drawn for want of necessary data. Two factors can beadduced as influencing the interest rate margin. One is a significantreduction in reserve requirements (Appendix Table Korea 7) together with thenarrowing of the gap between rates on general loans and those on preferentialcredits; the other is the accumulation of nonperforming loans. The costreduction due to the first factor might have been larger than the costincrease accounted for by the second, since the cost due to nonperformingloans was subsidized through the Central Bank's special rediscount facility.

Malaysia

4.44 The degree of competition among banks and between banks and NBFIs inMalaysia was strengthened by the deregulation of interest rates.Concentration among banks was gradually diluted since 1978 (Appendix TableMalaysia 6). However, as mentioned earlier, one of the reasons for thedeclining share of large banks in deposits during 1978-1981 was the control ofthe prime rate. Large banks, which lent more to prime borrowers, could notincrease interest rate on deposits as much as smaller banks could. Theconsequent diffusion of c:oncentration implied a greater degree of competitionin the banking sector, which received an additional fillip from the branchexpansion of commercial banks (Appendix Table Malaysia 10). Accordingly, theprofit rate of the banking sector represented by the ratio of gross profits tototal assets declined from 2.66% in 1978 to 2.03% in 1982 (Appendix TableMalaysia 6). The ratio was high even by the standard of advanced countrieslike the US, France and Germany (F. Pussac-Contando, 1984).

4.45 The interest rate spread widened slightly instead of narrowing afterinterest rate deregulation in both the banking system and the financecompanies. The interest rate margin in interest income minus interestpayments (as a proportion of total bank assets) was 2.19%. This figure maynot necessarily be a good indicator of the degree of competition andefficiency, but even after widening it compared favorably with correspondingratios in the US (Appendix Table Malaysia 9). The statutory reserverequirement ratio was quite low and, although the liquidity requirement ratiowas close to 20%, it did not entail high costs to banks since these could beheld in the form of interest-bearing securities. Despite intense competition,the interest rate margin increased after liberalization because of twofactors. One was the branch expansion of banks and finance companies, whichraised their overhead cost, and the other was extension of selective creditprograms. The first of these would be weakened as the branches becameprofitable, but the perpetuation of selective credit programs might widen thegap between deposit and lending rates.

PhiliRpines

4.46 One of the major purposes of the 1980 financial reform was toencourage competition through the introduction of universal banking bothwithin the banking system and between banks and nonbanks. However, it isdifficult to assess the precise impact of the reform on competition, inasmuchas recent economic and financial crises have caused financial institutions to

55

be concerned more with survival than competition. However, in the context ofreduced concentration in the banking system, as discussed below, it isreasonable to surmised that financial reform afforded greater scope forcompetition in the banking system.

4.47 The average size of the commercial banks in the Philippines is muchsmaller than that in other Asian countries; the largest, PNB, was ranked 82ndin a recent survey of the 200 largest banks in Asia (FSS, 1988). The numberof banks in the Philippines was very large compared to other Asian countries,and the authorities restricted new entry in 1974. Concentration was thereforenot a serious problem. As of June 1987, the 3-bank concentration ratio oftotal assets was 31.4%, and the 5-bank ratio was only 47%, down from 41.1% and50.0%, respectively, in 1979 (Appendix Table Philippines 8). The reciprocalof the Herfindahl Index, which purports to show the number of equal-sizedbanks, rose to 10.0 in 1986 compared to 8.8 in 1979, implying thatconcentration has decreased somewhat. However, it seems that the banks wereinterrelated as they were held by a few families. Perhaps the advent ofuniversal banking in 1980 might have paved the way for more competition.

4.48 Profitability measured by the ratio of profits before tax to totalassets was lower after financial liberalization (Appendix Table Philippines10). Similar trends were observed in profits after tax. The higher depositrates and the low return on loans carried over from the period of repressedinterest rates together caused a severe squeeze of bank profits (Remolena andLamberte, 1986).

4.49 The cost of intermediation, measured by the difference between theaverage cost of funds and the average interest rate on loans and investmentsother than reserve requirements, increased after liberalization. The factorsthat influenced intermediation cost were (a) the government tax, (b) highreserve requirements and the directed credit programs, and (c) bank profitmargins (Appendix Table Philippines 7). The government tax applied to allgross receipts including interest and capital gains of banks, and thewithholding tax applied to all deposit interest income except that onovernight interbank deposits. The reserve requirement was 21%, and it wasoften raised during economic turbulence. The increase in the intermediationcost since 1983 seems due more to tax and reserve requirements than to a lackof competition or low efficiency.

Indonesia

4.50 Financial reform in Indonesia emphasized interest rate deregulationand boosted competition in financial markets. Segmentation of loan marketswas considerably lessened when private and foreign banks were permitted toengage in business forbidden them before reform. After reform, the privatebanks could extend term loans up to a limit of one billion rupiah per loan,while foreign banks could provide export credits to businesses outsideJakarta. Likewise, national banks could extend low-interest export credits toforeign companies and joint ventures. Also the establishment of a market fornew instruments such as SBPUs (referred to earlier) helped integrate variousloan markets. As a result, banks made a greater effort to improveorganizational 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 particularareas but denied the same privileges to others. Banks with substantial accessto liquidity credits, which are essentially a discriminatory device, couldoffer lower loan rates on nonpriority credit than other banks by passing onpart of the subsidy they received. This apart, the state banks, by virtue oftheir ownership structure, enjoyed a specLal relationship with publicenterprises and government agencies and had a competitive edge over the rivalprivate banks.

4.51 The profitability of banks declined after the reform, and all thegroups of banks--state banks, private national and foreign banks except thedevelopment banks--were affected. Current profit as a ratio of total assetsfor all banks declined from 2.7% in 1982 to 1.8% in 1985 mainly as a result ofa sharp decline in operational income and a rise in nonoperational cost. Theinterest rate margin declined, reflecting a narrowing of spread on performingloans which was induced by growing competition, as well as losses resultingfrom nonperforming loans (Appendix Table Indonesia).

Sri Lanka

4.52 In Sri Lanka, after financial liberalization there was freer entry ofnew foreign banks, foreign currency banking units (FCBUs), and a variety ofnew domestic financial institutions. In consequence, there was a morecongenial atmosphere for competition, but Sri Lanka's financial marketsremained state-dominated and highly concentrated. State-controlledinstitutions claimed almost 80-85% of total assets of the financial system.The stifling influence of the state-owned banks on competition was exemplifiedby operations of the NSB, whose privileged position tended to distort thefinancial markets. It could attract deposits at whatever interest rates itthought fit despite the fact that its operating costs often exceeded the yieldon its assets; the negative differential was covered by a government subsidy.,

4.53 The persistence of several market imperfections caused the lendingrates to remain relatively high and thus to maintain, if not increase, a largespread between average deposit and lending rates. High operating costs as aproportion of total assets were the result of high government taxes andreserve requirements, approximately 1.5%. The interest rate margin as aproportion of total assets declined from 3.3% in 1980-81 to 3.0 in 1984, butoperating 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 decreasewas due more to the fall in income from foreign exchange business andcommissions (Appendix Table Sri Lanka 2) than to keener competition. Theevidence thus is not unambiguous as in other Asian countries where a reducedspread could be attributed to liberalization.

(d) Availability of Term Credit

Korea

4.54 With the development of corporate bonds, stocks and a venture capitalmarket in Korea, the availability of long-term and risk capital seemed toimproved greatly. Appendix Table Korea 11 shows the sources of funds ofcorporate business in Korea. The distinctive change between the 1970s and the

57

1980s was that the share of bank credit and foreign loans went downsignificantly with the corresponding rise in share of loans from NBFIs anddirect financing in the form of corporate bonds and stocks. It is notpossible, however, to know how much term credit flowed from the banking systembecause 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 demandand savings deposits toward fixed-term deposits, as evident from the rise intheir share in total deposits from 22.2% in 1978 to 55.1% in 1986 (AppendixTable Malaysia 11). Even among fixed deposits, those with a maturity of morethan 12 months increased substantially in the aftermath of liberalization.However, during 1981-1982 the share of longer-term deposits declined, probablybecause of high inflation and uncertainty about the real rates of interest,but since 1982 the share of longer-term deposits has begun to increase. Theshare of long-term loans by banks also increased gradually. The share ofloans of maturity of 4 years and more increased from 24.7% in 1978 to 31.5% in1983 (Appendix Table Malaysia 12). Thus the amount of long-term credit fromthe commercial banks after liberalization became ample. However, the overallavailability of long-term, industrial credit did not improve afterliberalization. The poor functioning of the corporate securities market(which may have been crowded out by the dominance of government securitiesissues) 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. Thesectoral allocation of bank credit reveals that less bank credit was allocatedto the manufacturing sector, even though it requires more long-term capitalthan other sectors (Appendix Table Malaysia 13).

Philippines

4.56 Since one of the major goals of the 1980 reform in the Philippineswas to augment longer-term lending by banks, the level of reserve requirementsagainst deposits of more than two years' maturity was lowered to reduceliquidity risk. Also, liberalization of the bank loan rate seemed to reduceinterest rate risk and extend the average maturity of loans. As a result, theshare of short-term loans in total bank credit declined but was made up by thecorresponding increase in the share of longer-term loans in total bank credit.However, this trend seemed to reverse after 1985, presumably'due to economicand political disturbances which affected not only the banks willingness tolend long-term, but also the demand for such credit (P. Honohan, 1988). Thisimplies that if the economy remains unstable (for whatever reason), no amountof financial liberalization alone is likely to motivate banks to lengthen theaverage maturity of their loans. In the adverse macroeconomic environmentafter 1985, several nonbank financial intermediaries failed. This was alsothe reason why the principal universal banks, which were supposed to beactively channeling funds into riskier ventures, shied away from such risks.

Indonesia

4.57 In Indonesia, financial reforms did not alleviate the shortage ofterm 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 localcurrency fell from 41.2% i.n 1983 to 39.8% in 1987, though these statisticsshould be interpreted circumspectly in view of their shortcomings. Thereluctance of banks to countenance term credit covering the entire period ofinvestment was principally attributed to the volatility of interest rates, adirect result of financia:L reform (as discussed earlier), and the mismatch ofmaturities between liabilities, with the bulk of them very short-terminvestment financing. The maturity of term loans was on average 10 years, asagainst the maximum maturity of deposits of 24 months. This mismatch posed aneven more serious problem when the share of longer-term deposits in totaldeposits decreased. Thus the proportion of 18-24 month deposits slipped from68.9% in 1982 to 7.7% in 1986; on the other hand, deposits with maturitybetween 6 and 12 months increased from 27% to 67% (Appendix TableIndonesia 7). The shift to shorter maturity observed in all categories ofbanks was due to the fact that interest rates, though high in real terms, werevolatile because of expectations of devaluation.

4.58 Though the impact of interest-rate volatility on the flow of termcredit from the banking system was severe, it was mitigated to some extent bythe term loan contracts with adjustable rates which constituted a bulk ofnonpriority term loans. Other essentially structural factors accounting forthe aversion of banks to undertaking term lending were the poor creditappraisal capabilities of banks and their faulty collateral practices.

4.59 The equity market was slow to develop in Indonesia, largely becauseof the unfavorable tax treatment of equities vis-a-vis alternative financialinstruments such as bank deposits, low disclosure standards, and the poorquality of auditing and accounting. Recently there has been renewed interestin reviving the moribund capital market. The authorities initiated a packageof measures directed toward mobilizing savings for purchase of divestedfinancial assets, newly issued securities of enterprises, new avenues forpublic participation in high-return equities of profitable businesses, andrestructuring of ownership of industrial enterprises to reduce theirdependence on short-term funds. It may be quite some time before the new planfor securities development takes concrete shape.

Sri Lanka

4.60 At the end of 1985, term credit with maturity of over one yearconstituted approximately 30% of total bank credit, and credit with maturityof over 5 years formed about 10%. The flow of such credit has increased sincethe financial reform. In addition to banks, other institution such asdevelopment 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 bankableprojects have not been forthcoming because of political uncertainty.

4.61 The equity market in Sri Lanka opened during the 1960s has gainedstrength in the aftermath of financial liberalization. At present there areabout 170 companies listed on the stock exchange, of which almost one thirdwere 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 lackof attractive stock offerings, political uncertainties and, most important,the absence of a well-designed legal framework. On the supply side, a largeproportion of stock was in the hands of closely held companies, and thetendency of these to divert profits from shareholders made it difficult for asecondary 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 dollarwas fixed during 1974-1979. With a substantially higher domestic inflationrate than the rest of the world during this period, Korea's exchange rateappreciated significantly. Domestic bank interest rates, although high innominal but not in real terms, were also higher than those prevailing abroadand were sustained at that level because of stringent foreign exchangecontrols and the expectation of exchange rate depreciation. Since 1980,however, despite continued control on capital flows, the gap between domesticand foreign interest rates was reduced. The effective cost of foreigncurrency loans was higher during 1980-1985 than in the 1970s (Appendix TableKorea 12). This trend has been reversed since 1986, however, as the wonappreciated against the US dollar with the emergence of a current accountsurplus. On the whole, the level of domestic interest rates was not sensitiveto foreign interest rates to the extent expected because of the insulation ofthe domestic financial markets from the international markets. On the otherhand, it could be argued that capital controls were instrumental in preventingcapital flight from Korea in the early 1980s when the public's confidence inthe Government's ability to manage the economy was very low, the politicalsituation was volatile, and there was widespread distrust of the domesticbanking system spawned by scandals and financial vulnerability. With freecapital movement, Korea might have lost control over the deposit base ofdomestic financial intermediaries, as happened in other countries like thePhilippines, Indonesia and the Southern Cone countries in Latin America.

Malaysia

4.63 Malaysia's foreign exchange system was virtually free ofrestrictions, and short-term capital movements were quite responsive tointerest rate differentials between Malaysia and overseas, particularlySingapore and the US. However, the level of domestic deposit rates was not assensitive to international interest rates as had been expected, perhapsbecause participants in the foreign exchange market were mainly commercialbanks (general depositors did not have easy access to this market). Interestrates in the interbank market were an exception to this pattern. The level ofdomestic deposit rates has remained well below the Eurodollar rate adjustedfor exchange rate changes during the last 15 years (Appendix Table Malaysia8).

PhiliRRines

4.64 Financial liberalization did not seem to contribute much to theintegration of domestic and foreign interest rates in the Philippines. During

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the 1970s, when the nominal exchange rate was stable, the cost of domesticloans was consistently higher than that of foreign loans (Appendix TablePhilippines 12). This was completely reversed in the 1980s when the cost offoreign loans remained much higher and the gap in fact widened, due mainly tothe volatile movement of the exchange rate, residual controls on foreignexchange and uncertainty about inflation. The Philippine experience was by nomeans unique, as even in the most efficient financial markets of industrialcountries such as those in Japan and the US, interest rate parity has not heldwhen exchange rates have been most volatile. However, domestic interest rateswere 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 inIndonesia even before financial liberalization because of lack of restrictionson capital flows. Before the large devaluations of rupiah, it was generallycheaper to borrow in the foreign markets (Appendix Table Indonesia 11). Since1983, however, the effective cost of borrowing abroad increased sharply as aresult of a series of devaluations. Interest rate parity generally held butwas weakened when expectations did not always correspond to actual changes inthe exchange rate. Other factors influenced domestic interest rates evenunder conditions of complete capital mobility, as evidenced by experiences inmany industrialized countries. A lag in the downward movement in realinterest rates was induced by expectations about exchange rate depreciation,which in turn could heighten inflationary expectations. In part, theseexpectations were fueled by the large swap premium offered by Bank Indonesiain providing forward exchange cover for approved private-sector foreign-debtobligations (V. Sundararajan and L. Molho, 1988).

Sri Lanka

4.66 In Sri Lanka, domestic deposit rates moved with foreign interestrates adjusted for actual changes in the nominal exchange rates. The gapbetween the two rates has been narrow since 1977, except for 1985-86 whenforeign borrowing was more expensive than domestic.

(f) Ouality of Banks' Portfolios: Nonperforming Loans

Korea

4.67 Following financial reform, Korea's banking system suffered fromheavy nonperforming loans in the 1980s. Although the precise total is notknown, their impact was sufficient to threaten the solvency of the main banks.The Government could not further liberaLize the banking system (despite itsavowed objective) and in fact supported the banks financially. The largenonperforming loans of Korean banks were not mainly a result of financialliberalization; they were in some measure the legacy of excessive governmentintervention in credit allocation in the 1970s combined with the effects ofexternal shocks which hit the industrial sector. The problem of nonperformingloans was eased by the Central Bank's low-cost funds to support the commercialbanks' outstanding nonperforming loans, a tax exemption to facilitate write-offs and restructuring of corporate firms, and above all a strong economicrecovery.

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Malaysia

4.68 Heightened interest rate competition among banks in Malaysiafollowing liberalization did not per se significantly affect the quality oftheir loan portfolios. But the combined effects of liberalized lending rates,which in real terms rose substantially, and economic downturns since 1984 havebeen adverse to the commercial banks' portfolios, as reflected in the sharpincrease in provisions for bad and doubtful loans since 1984 (Appendix TableMalaysia 15). High real lending rates placed heavy pressure on corporateprofitability and performance when the economy faced a downturn during 1984-86and 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 inthe Philippines and elsewhere. There are several reasons for this. First,nominal interest rates were not high, although real interest rates weresubstantially high owing to stable inflation. Second, the corporate sector'sfinancial structure was less vulnerable to changes in interest rate levelsbecause of its low debt/equity ratio. Third, government intervention inbanks' portfolios prior to reform was not pervasive and, except for guidedlending programs, loans were generally based on the decisions of veryconservative bank managers. Therefore, unlike banks in Korea, the Philippinesand Indonesia, Malaysia's commercial banks did not have poor portfolios tobegin with. Fourth, the Central Bank devised supervisory regulations whichwere implemented with efficiency and speed. In the early 1980s it undertook aseries 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 sectorcompanies of all sizes experienced actual or potential financial difficulties.Nearly half of all private development banks had arrearage rates of 20% ormore on their loan portfolios. In the case of government-owned banks, theproblem was even worse. In 1986, the Philippine National Bank (PNB), thelargest commercial bank, and the Development Bank of Philippines (DBP), becamede facto insolvent and were bailed out by transfer of nonperforming assetsamounting to 80% and 90%, respectively, of total assets, to the governmentestablished Asset Privatization Trust (APT). Loan portfolios of privatecommercial banks was seriously affected, although their position wasrelatively 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% inreal 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 thriftinstitutions 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 widelybelieved that the banks had heavy arrearages which made them financiallyvulnerable. This was particularly true of state-owned banks, whose loan

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exposure was so large that they could not have recovered their principal andinterest through asset trans:Eer or sales in the event of foreclosure ofborrowing firms. Besides, cumbersome legal procedures to recover loansremoved liquidation as a viable option. Under such circumstances, banks withheavy and mounting arrears tended to compensate themselves by increasing loanrates as much as two percentage points. Apart from the inherent inefficiencyof industrial firms fostered by a long history of protection and subsidy, themain cause of nonperforming loans was the impact of the exceedingly highinterest rates. It was paradoxical that creditor institutions tried tosalvage 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, thoughprecise figures are not available. The government corporations were among thedefaulters on loan repayment to banks. The Government understood the gravityof the situation and set up a committee to devise appropriate legal andadministrative procedures to expedite loan recovery by banks and also to impelbanks to augment their provision for bad and doubtful debts, something theyhad become lax in doing in view of the nonexemption of such provisions for taxpurposes. The Central Bank, too, was seized of the need to strengthen itssupervisory machinery so that bank balance sheets would reflect their truefinancial worth.

(g) Corporate Sector's Financial Structure

Korea

4.72 With low-interest-rate policies and government control of the bankingsystem (which reduced the cost of debt and the risk of investment), thecorporate sector, especially large government-favored firms, became highlyleveraged (Y. Cho, 1986). The debt/equLty ratio peaked at more than 400% in1980 (Appendix Table Korea 2). As a result, Korean firms became veryvulnerable to changes in interest rates. With increasing real interest ratesand receding government commitment as a risk partner following privatizationof banks and gradual phasing out of government intervention in the creditallocation, the debt/equity ratio of Korean firms declined slightly in the1980s.

Malaysia

4.73 The corporate sector in Malaysia was much less susceptible to changesin the level of interest rates than that in Korea, the Philippines andIndonesia. The debt/equity ratio of Malaysian firms was relatively low, alittle higher than 100%, while the ratios for Korea and Philippines were inthe range of 300-400%. This ratio had increased during 1972-1978 butdecreased after liberalization, reflecting the higher cost of bank debt(Appendix Table Malaysia 14).

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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 borrowingat high interest rates. The ratio of total liabilities to total assets forthe top 1,000 corporations rose from 78% in 1979 to 84% in 1985, equivalent interms of debt/equity ratio to 315% in 1979 and 442% in 1986 (AppendixPhilippines Chart P2). The highly leveraged financial structure of thecorporate sector was the principal reason for the financial crisis afterfinancial reform.

Indonesia and Sri Lanka

4.75 Data on financial corporation structure in Indonesia and Sri Lankaare scarce. The debt/equity ratio of firms in Indonesia was estimated to bearound 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 thecorporate sector was hurt considerably by both high interest rates andfrequent significant rupiah devaluations, but in the absence of necessarystatistics no firm conclusions can be drawn.

Intercountrv Experience: Divergence and Similarity

4.76 After observing the impact of financial liberalization on financialsystems, it might be useful to know, in an overall sense, why the consequencesof financial reform across these five countries lacked uniformity and whethertheir divergence might be related to differences in the approach and modalityof the reforms undertaken in each of the countries. Of all the fivecountries, Korea and Malaysia both exhibit the beneficial impact of financialliberalization, but for different reasons. The main emphasis in Korea'sfinancial 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 tobegin with. In contrast, liberalization of the banking sector was muchslower. In addition, care was taken to continue the controls on the capitalaccount, which rendered interest rate arbitrage relatively difficult.Consequently, domestic influence on interest rate determination remained muchstronger than foreign influences. Progress in orienting the financial sectorto competitive conditions without abandoning government intervention was madeconcurrent with positive macroeconomic developments such as the favorable turnin the terms of trade, stable inflation, a declining deficit in the currentaccount of the balance of payments, and a lower fiscal deficit. The inter-action between macro and micro aspects of economic policy strengthened toboth. One feature of Korea's financial reform experiment which contrasts withthose in other countries was what the Korean authorities accomplished inregard to the banking system's nonperforming loans. It became apparent in theearly part of the 1980s that the already large size of nonperforming loans wasexpanding and threatened the survival of the banking system. The authoritiesdid not force the pace of reform but in fact retracted it by (a) providinglow-cost funds through prompt downward adjustment in banks' nominal interestrates as inflation began to decelerate, and (b) taking determined steps towardcorporate financial structuring. Thus, the authorities bought time until

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economic recovery was well on its way. By following this pragmatic approach,Korea succeeded not only in strengthening the macroeconomic environment, whichhad already benefitted from vigorous adjustment policies in force, but also inavoiding unfavorable fallout from the reform.

4.77 Malaysia, on the other hand, succeeded in its main objective offinancial reform, though its approach and its macroeconomic conditions weredifferent. Malaysia's so-called reform, unlike Korea's, was confined to onlythose banks whose interest rates were freed from prevailing restrictions;there were no controls on interest rates of finance companies (they wereliberalized in 1973), the capital account was free, and competition amongbanks was intense. Governmetnt interventLon was minimal and there waspervasive market determination of interest rates and other financialtransactions even prior to interest rate deregulation. In a way, thefinancial reform in Malaysia was only a continuation (with greater emphasis)of the well-established tradition of restraint in interference with thefinancial system. Despite umfavorable macroeconomic developments--here too,the contrast with Korea is striking--of adverse terms of trade, large fiscaland external-accounts deficits (the negative effects of which were mitigatedby a stable inflation rate), Malaysia maintained the momentum of its financialliberalization without untoward consequences, largely because of a stableinflation rate. Malaysia dLd not escape a rising burden of bad and doubtfuldebts, a consequence mainly of the severe economic recession which coincidedwith interest rate deregulation, but they were not as burdensome as in Koreafor a variety of reasons, and the banking system could live with them withoutmuch difficulty. For one thing, nominal interest rates did not escalate asmuch as elsewhere, though real interest rates remained high and even inched upslightly due to the stable inflation rate. Second, the financial structure ofthe corporate sector was less sensitive to interest rate changes because of alow debt/equity ratio compared to that in Korea, the Philippines, andIndonesia. Third, the banking system had a very low level of bad and doubtfuldebts to start with because of the Central Bank's effective supervision andbecause the banks had autonomy in determining loan allocation before and afterthe reform. Malaysia thus could maintain vigorous expansion of its financialsector, deepening and w:Ldening it, with a policy of pronounced marketorientation. It was therefore all the more commendable that it accomplishedthis despite adverse macroeconomic circumstances at the beginning of itsfinancial reform.

4.78 Philippines and Indonesia present quite different situations. Thedismantling of interventionist regimes was telescoped and was even more far-reaching in the context of capital mobility. At the start of theliberalization programs, the Philippine and Indonesian financial sectorsreacted well to the removal of phasing out of government intervention, as seenin the attainment of positive real interest rates and faster growth in thefinancial sector. But macroeconomic developments turned sharply adverse forboth countries. The Philippines was enfeebled by the second oil shock at theend of the 1970s, political turmoil and a balance of payments crisis. In late1983, the situation deteriorated further with the freezing of foreign credit,severe import reductions leading to a decline in investment, and a consequentdeep recession. Goverrnment intervention became imperative to bail out severalbanks and take over some private commercial banks. The situation continueduntil 1985. A similar pattern of events took place in Indonesia. Because the

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fiscal and balance of payments deficits remained large, persistentexpectations of rupiah depreciation kept domestic real interest ratesintolerably high. Thus, both in the Philippines and Indonesia, the high levelof real interest rates greatly aggravated the vulnerability ef the financialsystem, particularly due to the highly leveraged corporate financial structurein both countries, and the size of nonperforming loans ballooned. In thePhilippines, both private and government-owned banks were severely affected byhigh and growing arrearages. The authorities were eventually forced to bailthem out.

4.79 In Indonesia, the financial crisis was more or less of the sameintensity as in the Philippines. First of all, in the wake of general liber-alization, nominal and real interest rates rose sharply. Though inflationremained stable after reform, expectation of currency depreciation raised theexpectation of inflationary pressures, which added to the high level of realinterest rates. Naturally, business firms groaned under the heavy burden ofhigh interest rates, and the high rates in turn adversely affected the loanportfolios of banks, The profitability of financial institutions was affectedin two ways. The magnitude of problem loans reduced the average return onbank assets, and new avenues for lending shriveled. It is estimated that thereturn on assets of banks ranged from 0.2% to 4.3%, with larger state banks atthe lower end of this range. On the other hand, rapid growth of high-interestdeposits raised the banks' costs and squeezed profits Second, the state banksbore the major brunt of nonperforming loans. The state banks dominated thefinancial scene and accounted for about 70% of all loans. By virtue of theirownership, they had preferential access to captive deposits from publicentities and liquidity credits from Bank Indonesia. This enabled them towield excessive power in the loan market without having to put in efforts tomobilize deposits. With such monopoly power, there was no compelling need forbanks to discard outdated operational practices or improve the management oftheir loan portfolios. Even where competition prevailed, as in the othersectors of the financial system, it had a deleterious impact on the bankingsystem's soundness because small and average-sized banking units indulgedexcessively in deposit-mobilizing activities by offering very high nominalinterest rates even though they could not use those funds for profitable loanoperations. Third, though there was an attempt to reduce liquidity credits,their proportion in the total outstanding credit of banks remained the same asit 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 tolarge 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 depositorsfrom holding long-term deposits), the banks could not continue to extendlonger-term credit and starved the economy of investment finance even morethan before financial reform.

4.80 Sri Lanka's liberalization regime was comprehensive and embraced allsectors of the economy, though in contrast to the Philippines and Indonesia,deregulation of the financial sector was more limited and gradual. The mainreform of the financial sector was the removal of interest rate ceilings andwatering down of the selective credit programs. However, the full effects ofliberalization were not as beneficial as expected because they were offset byexternal and internal shocks beyond the control of the authorities. But

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unlike Korea and Malaysia, and far from easing the impact of the shocksthrough appropriate adjustments in the macroeconomic policies, Sri Lanka infact thwarted its liberalization strategy by following a dissonantmacroeconomic policy. When government savings were negative, the authoritiesjacked up the investment rate through infusion of borrowed foreign resources,and this led to appreciation of the real exchange rate. However, theresulting consequences for the financial system were not as severe as in thePhilippines or even Indonesia. Nonperforrning loans no doubt increased, butthey did not reach the relative dimensions seen in the Philippines andIndonesia, owing to Sri Lanka's strict adherence to prudential regulations.

4.81 What emerges clearly is that there was little doubt about the need offinancial liberalization as an antidote to financial repression. Disagreementis more in regard to the timing and sequencing of reforms. Discretionarypolicy adjustments proved to be superior to the fixed and inflexible rules.

D. Summing UR

4.82 The consequences of financial liberalization in all these countriesmay be broadly summarized in specific areas.

Interest Rates

4.83 The expected impact of deregulation on interest rates in all fivecountries was in the desired direction, i.e., upward adjustment. In Korea,although interest rates were controlled by the Government, they generallymoved to a positive level mainly because of a decline in the inflation rateand flexibility in administering that policy. The Korean authorities adopteda pragmatic approach to interest rate deregulation as evident from the factthat the banks' interest raties were adjusted downward even in the face of highinflationary expectations and even though the financial vulnerability of thecorporate sector could have had an adverse impact on the banks. On the otherhand, dismantling of preferential interest rates and a partial liberalizationof interest rates in the nonbanking sector have facilitated the integration offormal and informal markets. The impact of liberalization on domesticinterest rates in Malaysia was modest at the beginning, if only because beforeliberalization market forces had strong influence on them and the gap to bemade up was limited. By late 1981, after the new interest rate mechanismbased on the BLR was introduced, bank deposit rates became more sensitive tointernational interest rates. The integration of various interest ratesapplied more to the deposit rates because deposits with finance companies wereperceived to be close substitutes for bank deposits. However, thesegmentation of interest rates between those on bank assets and liabilities onthe one hand and government securities on the other remained immune from theimpact of liberalization. The term structure of interest rates changedsignificantly, particularly due to a stable inflation rate. In Philippines.though the nominal interest rates on bank deposits and loans increasedslightly at first, real interest rates became positive with declininginflation. But the upward movement of interest rates later received apowerful impetus because of a severe monetary contraction to mop up liquidityrthrough issue of high-yield Central Bank bills with which the banks had tocompete. During the period 1984-86, the market-determined interest rates werevery high, higher than the real return on investment. The domestic interest

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rates were largely well integrated. In Indonesia, the main impact ofliberalization was on the interest rates on assets and liabilities of thestate banks, since the other banks' rates were freely determined even beforeliberalization. The real interest rates became positive and substantiallyhigher than even the marginal rate of return on investment. The domesticinterest rates were well integrated. Sri Lanka followed other countries inregard to deposit interest rates: they became highly positive (except in twoyears) after liberalization. Though government intervention continued, marketforces were given greater scope to influence the level of interest rates. Thetreasury bill rate was used as an indicator of the authorities' intention asto how other interest rates in the market should move. This ensured thatinterest rates would change in the desired direction in response to a changein the inflation rate.

Financial Sector Growth

4.84 The beneficial consequences of financial reform were seen in thefaster growth of the financial sector. In Korea, the ratio of M3 to GNP rosesharply after 1981 and faster than the M2/GNP ratio, implying that nonbankexpansion of the financial sector was greater than bank expansion. Also, themarkets for corporate bonds and commercial paper recorded rapid growth,facilitated by the absence of government nonintervention in that sphere and bythe unavailability of bank finance due to tightened credit control. There wasclear evidence that a growing portion of private savings was held in financialassets in view of the very attractive return on them. In Malaysia. the ratioof M3/GNP, which includes time and savings deposits with nonbanks, more thandoubled. In the first flush of financial reform, the financial system in thePhilippines expanded too, though moderately. Since 1984, however, its growthrate turned negative in the context of an adverse macroeconomic environment, aliquidity crisis and widespread bank failures. In Indonesia. the gross assetsof the organized financial sector almost tripled since 1982, a growth rate ofalmost 23% p.a. in nominal terms. In addition, the range of noncreditfinancial services widened considerably. Only in Sri Lanka did the financialsystem not record any perceptible growth. Financial reforms succeeded more instemming the prereform decline of the financial system than in inducing rapidgrowth.

4.85 It is clear from the above that the growth of the financial sectorhas been rapid when the level of real interest rates is high and stable. Thisagain points to the importance of stable inflation rates. Korea, Malaysiaand, to some extent, Indonesia had quite stable inflation rates during 1982-86and experienced rapid growth of the financial sector. The Philippines, whichhad highly fluctuating inflation during 1983-85, experienced contraction ofthe financial sector, although the average real interest rate was quite highduring this period. However, the financial sector grew rapidly during 1980-83when inflation was relatively stable. Sri Lanka's financial sector did notgrow fast, presumably due to fluctuating and high inflation in the laterstages of reform. Japan and Taiwan, which achieved rapid financial sectorgrowth during the last two or three decades despite their controlled bankingsystem, also had a very low and stable inflation rate. This suggests that arelative price stability may be as crucial as (or even more crucial than) theliberalization of the banking system and the interest rate Rer se to theachievement of rapid and sustained growth of the financial sector.

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Competitiveness of the Financial System

4.86 Competitiveness of the banking system following liberalizationincreased perceptibly in all five countries, though it varied in degree fromcountry to country. In Korea, dealing in new financial instruments byprivatized banks and NBFIs, expansion of the direct credit market and allowingfreer entry of foreign banks were the main catalysts in promoting competition.In Malaysia. competitive forces were boosted by liberalizing banks' interestrates and making competition between banks and NBFIs more intense. Theexpansion of branches by banks and the relative increase of small banks' shareduring the period of control of the prime rate also contributed to greatercompetition, and the entry of foreign banks helped reduce the inertia amongbanks which had characterized their operations before reform. In Philippines.bank concentration was not muich of a problem even before liberalization, andcompetition was enhanced by universal banking. The restructuring of twolargest government-owned banks led to some reduction in the marketconcentration ratio though bank ownership continued to remain in the hands offew families. The main factor that spurred competition among banks inIndonesia was the abolition of control on deposits and loan interest rates ofstate banks which had a major share in total financial assets. Once thesebank were free to compete for funds in the market, the private and other banksbecame more alert to profit possibilities than before. In Sri Lanka. theinterbank market acquired new strength as new instruments emerged and FCBUswere established.

Term Credit

4.87 The impact of liberalization on availability of term credit was notuniform across the five countries. In Korea, there was distinct improvementin the flow of term credit from nonbanks such as insurance, investment andtrust companies and from the securities market because the growth of NBFIs wasvigorous in the aftermath of liberalization and the market for bonds andstocks developed rapidly in the more competitive environment. In Malaysia.the banks continued to be a major source of investment funds, as theircapacity to supply such funds increased with the faster growth of longer termdeposits following interest rate deregulation. Unlike Korea, however, thesecurities market remained marginal as a source of long-term funds because itwas crowded out by the issue of government bonds sold in captive markets. Inaddition, the share of development financial institutions in total credit wasvery small in Malaysia. The PhiliRpine experience was mixed. Long-term fundsfrom banks were augmented when reserve requirements against longer-termdeposits were lowered and when bank loan rates were deregulated, therebyattenuating the maturity risks. With the extension of the average maturity ofdeposits, the banks' ability to provide such funds was greatly enhanced,though political turbulence, adverse macroeconomic developments and thefinancial fragility of banks have combined to reduce the role of banks in thisarea since 1985. In contrast, in Indonesia. the banks were constrained tolend medium- and long-term because of the pronounced volatility of interestrates and the mismatch of maturities between liabilities, predominantly ofshort-term nature, and loans required for investment financing. The capitalmarket was stifled by the absence of infrastructure required for vigorousdevelopment and by the cliscriminatory taxation policy. Sri Lanka paralleledthe Philippines and Malaysia in respect of the availability of long-term

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funds. In more liberal financial conditions, commercial banks together withdevelopment banks came to be the single largest source of capital funds to theprivate sector. A real limiting factor in Sri Lanka was the relative shortageof demand for long-term funds, in view of the lack of bankable projects.Unlike Korea but like Indonesia and Malaysia, the capital market could notdevelop for want of, among other things, an appropriate legal framework.

4.88 Liberalization of interest rates does not seem to have significantlyimproved the availability of long-term credit. In two countries (Malaysia andthe Philippines) in which interest rates were liberalized, the averagematurity of loans and deposits of the banking sector increased. Yet the majorpart of bank loans (more than 70%) was short-term (less than one year'smaturity). Also, the maturity of loans tended to be shortened when theinflation rate was high and volatile: it is essential that interest ratesremain stable if banks are to consider lending medium and long (Indonesia).In order to enhance the availability of long-term credit and risk capital, theencouragement of new instruments and new markets seems necessary along withstable inflation and interest rates. There is an apparent limit forcommercial banks to provide long-term industrial credit. In addition, astable inflation rate may be important not only to encourage the developmentof those instruments and markets, but also to increase the maturity of bankloans. Korea's experience of the 1980s was liberalization through theexpansion of NBFIs and the securities market, while the Philippine experiencewas through liberalization of bank interest rates and allowing commercialbanks a wider range of activity. Korea seems to have achieved moresignificant progress toward mobilizing long-term credit and risk capital inthe industrial sector than did the Philippines and Indonesia.

Intermediation Costs

4.89 The experience of these five countries in regard to intermediationcost was diverse to a degree that nothing definitive can be said about howliberalization influenced it. In Korea, the cost of intermediation fell,determined as it was by two factors opposed to each other. One, the downwardinfluence, was the scaling down of reserve requirements and narrowing the gapbetween rates on preferential and general loans; this was counterbalanced bythe rise in losses from nonperforming loans. It could be argued that if thenonperforming loan problem had not arisen, intermediation costs would havedeclined as a consequence of growing competition after liberalization.Insofar as Malaysia is concerned, there is evidence that the intermediationmargin widened slightly instead of narrowing, as expected after the reform.Perhaps this could be attributed to the perpetuation, though in somewhatweakened form in recent years, of the oligopolistic banking structure inMalaysia. Additionally, it could be explained by the rise in overhead costsof banks in the context of rapid branch expansion as well as by thecontinuation of selective credit programs. In Philippines, the cost ofintermediation rose as in Malaysia, but the reason was different. Theincrease was due to fiscal impositions such as high reserve requirements aswell 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 narrowedbecause of reduction in the interest rate margin on both performing andnonperforming loans. The first of these was a clear indication of the impact

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of a growing competition among banks. The latter was more a reflection of thefinancial difficulties in,to which banks were dragged by high and volatile realinterest rates. In Sri Lanka, the interest rate margin declined slightlysince financial reform. Considering that reserve requirements were quitehigh, even a small downward change in the interest rate margin could beinterpreted as an efficiency gain resulting from growing competitiveness inthe financial markets.

4.90 The liberalization of interest rate has not significantly reduced theintermediation spread in the Asian countries. After liberalization, therelatively high spread continued (Philippines) or even slightly increased(Malaysia). This is because a substantial part of the interest rate spreadwas caused by high government taxes, reserve requirements (Philippines), andthe burdens of selective cretdit program (Malaysia, Philippines, Indonesia).The costs of these increased as inflation pushed up the opportunity cost offunds. The increase in nonperforming loans and the oligopolistic nature ofthe banking system might also have been the reasons for the sustained highspread. This suggests that liberalization of interest rates and promotion ofcompetition among financial institutions alone are not sufficient to ensurereduced intermediation cost. Fiscal imposition on the financial sector suchas administering selective credit programs (or portfolio restriction) shouldalso 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 domesticinterest rates with foreign interest rates were different for each of thecountries and were not always in the direction expected a priori. Followingfinancial reforms and a substantial depreciation of the currency, the gapbetween the domestic and foreign interest rates in Korea declined andreversed, with the foreign interest rates exceeding the domestic ones, asituation quite opposite the one that prevailed during the 1970s. For allthis, however, the Korean interest rates could not be considered to besensitive, to the extent expected, to international interest rates. Domesticfinancial markets were insulated from the foreign markets through effectivecontrols on capital movement, and direct interest rate control ruled out theapplicability of parity conditions. Indeed, the shielding of the capitalaccount prevented capital flight in the early 1980s and ensured relativesuccess of financial reforms. In Malaysia, while the domestic interest rateswere quite sensitive to interest rate differentials between Malaysia andabroad, the degree of sensitivity was not as high as expected, presumablybecause the nonbank public had little access to foreign markets. ThePhilippine experience was mixed. The cost of borrowing domestically exceededthat of borrowing abroad in the 1980s, and the gap widened due to the volatilemovement of the exchange rate, residual controls on foreign exchangetransactions and uncertainty about inflation. In Indonesia. the reversehappened. Before reform, foreign interest rates adjusted for depreciationwere lower than domestic rates, though the gap was small. The situationturned around after financial reform, with the cost of borrowing abroadexceeding that in domestic markets after a series of devaluations. Parityconditions generally held, but much too weakly. This was not surprisingviewed in the wider international perspective. In Sri Lanka, the domestic

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interest rates generally moved with foreign interest rates adjusted for actualchanges in the nominal exchange rate except in 1985 and 1986, when foreigninterest rates rose more sharply than domestic rates. On the whole, it ispossible to conclude that, following financial liberalization, though theinfluence of foreign factors on domestic interest rates increased, fullintegration of rates did not take place even when capital movement was almostfree, as in Indonesia, Malaysia, and the Philippines.

Ouality of Bank Portfolio

4.92 All five countries were saddled with nonperforming loans in varyingdegrees, with the Philippines bearing the greatest burden and Malaysia thelightest. The manner in which the problem of nonperforming loans was handledalso was different. In Korea, the problem of the nonperforming loans wasresolved gradually and without deleterious impact on the solvency of banks,largely due to substantial financial support from the Government, taxtreatment for writing off bad debts, concessional credit by the Central Bankto commercial banks, and other restructuring measures adopted to rescue thecorporate sector, and also partly because of the onset of a strong economicrecovery. Nonperforming loans never assumed a large dimension in Malaysia.and the nominal interest rates were never too high; the corporate sector wasless exposed to shocks of higher interest rates because of stable inflationand a prudent Government. The less-interventionist regime prior toderegulation of interest rates did not permit nonperforming loans toaccumulate on a large scale. However, since 1985, as real interest ratesincreased and the economy slowed, banks ended up with a growing burden ofarrears. In PhilipRines, of course, the banking system virtually collapsedand the Central Bank had to undertake a sizable bailing-out operation. TheIndonesian financial system also faced the serious problem of a growing volumeof bad and doubtful assets in bank portfolios. The main reason for this wasthe high and volatile level of interest rates in relation to the productivityof capital. This adversely affected the corporate sector first, and then thefinancial sector. In Sri Lanka, too, the poor portfolios of banks posedserious problems, but they scarcely reached the levels experienced in thePhilippines or even Indonesia and remained manageable, partly because theregulation of the financial system was strict and the Government's otheractions were timely.

Corporate Financial Structure

4.93 Interest rate deregulation affected each of the five countriesdifferently, depending on the nature of the initial financial structure of thecorporate sector and the changes brought about. In PhilipRines and Indonesia,the corporate sector's high gearing ratio on the eve of financialliberalization increased even further, due mainly to distress borrowing. Thisrendered it more sensitive to changes in interest rates. In Korea's case, thedebt/equity ratio declined from its prereform-period level in response to theprivatization of banks, the phasing out of selective credit programs, and highreal interest rates. The government's commitment as a risk partner receded.In Malaysia. the corporate debt/equity ratio was relatively low and declinedsomewhat after the reform.

72

V. FINANCIAL LIBERALIZATION IN CHILE. ARGENTINA AND URUGUAYAk COMPARATIVE PERSPECTIVE

5.1 Analysis of the impact and modus operandi of financial liberalizationwill gain depth, breadth and relevance if the Asian countries' experiences arecontrasted 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 instrumentalityand consequently yielded different outcomes. All three countries had broadlysimilar macroeconomic backgrounds, social structures, cultural heritage andhistorical circumstances. They had, to begin with, long records of highinflation, fiscal imbalances, perpetual balance of payment crises, pervasiveand long-lasting interventionist regimes embracing all the sectors of theeconomies, lopsided production structures, and so on. They pursued financialliberalization strategies more or less similar in design. In Chile, bothmacroeconomic stabilization and financial reform policies were initiatedconcurrently, while in Argentina and Uruguay financial reform precededstabilization. The main thrust of the stabilization policies was to reducereal exchange-rate fluctuations and de-escalate the raging inflation which haddistorted relative prices and increased concentration of financialtransactions in instruments with short-term maturities in the context ofuncertainty about future inflation.

5.2 In what follows, the macroeconomies of these countries prior toliberalization will be described briefly, and attention will be drawn toprominent features of their financial systems on the eve of financialliberalization. Since there was close and continuing interaction betweenstabilization and financial r-eform policies, key elements of the stabilizationpolicies will be scrutinized to ascertain the truth of the proposition thatinconsistent 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 afterliberalization will be presented. This discussion will not be detailed as inthe case of the Asian countries. Financial reforms in the Southern Conecountries of Latin America have been extensively analyzed and commented upon,and this paper has leaned considerably upon these analyses for importantstylized facts, if not analytical perspective. Towards the end of thesection, the experiences of the Southern Cone countries will be juxtaposed tothose 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 countrywas in economic doldrum. The average annual growth rate of real GDP wasbarely 0.7% during 1971-73% and the fixed investment growth rate was minus9.8% (V. Corbo, J. de Melo, J. Tybout, 1985). Inflation assumed seriousproportions: the average annual rate was 150%, fueled by average fiscaldeficits of 12.5% of GDP and financed mainly by borrowing from the CentralBank. The current account deficit of the balance of payments in relation toGDP was at an average annual rate of 3.2% (Table 17). Economic stagnation inChile was a hangover from past severely repressive government policies. Priceand exchange controls were pervasive, and the financial sector was heavily

73

intervened. Multiple exchange rate practices prevailed with a pronounced biastoward import substitution. When the new Government took over in 1973, itinitiated economic policies aimed at freeing commodity markets and enforcingfiscal discipline. Since the change in economic policy coincided with therise in copper prices Chile's economy absorbed the first oil shock withoutmuch difficulty (V. Corbo, 1985). After the economic policies changed gear,inflationary pressures measured by the GDP deflator surged, reaching almost1,000% in 1974. The price rise was large, as latent inflation was transformedinto open price increases with the elimination of all controls. In 1974, theauthorities launched a sweeping program of financial liberalization.

5.4 Argentina, on the eve of financial reforms in 1976, was in no bettershape than Chile. The average rate of growth of real GDP was 2.8% during1971-75, and gross investment as a ratio of GDP was 20.5% (Table 24-I). Therate of inflation was around 82% in the same period, a fact that is by nomeans surprising in the context of a high fiscal deficit at 12% of GDP, mainlyfinanced by Central Bank credit (V. Corbo, J. de Melo, J. Tybout, 1985). Thebalance of payments was also under serious pressure.

5.5 Uruguav's economy was equally severely afflicted by macroeconomicimbalances. The average growth rate of GDP during 1971-75 was only 1.6%. Thegross fixed. investment/GDP ratio was, at an average of 10.8%, the lowestamong the three countries; the domestic savings at average 12.3% of GDP washigher than domestic investment (Table 24-I). Terms of trade, alreadyadverse, declined further during 1971-75. The fiscal situation was alsounfavorable, but compared to Chile and Argentina, the fiscal deficit at 3.5%of GDP was relatively low. It was, however, sufficiently serious to sparkcapital flight because it raised expectations of inflationary pressures(Harberger, 1975). The loss of foreign exchange reserves was moderate onlybecause of stringent restrictions on capital flows and trade. The averagebalance 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 countrieswere stunted by one type of repressive intervention or another. In Chile, theregulated interest rates did not respond to changes in the inflation rates andwere negative in real terms almost throughout the 1970s, and, in fact, hadbeen so since the 1950s (M. Garces, 1985; V. Corbo, 1985). This naturallyslowed the growth of financial savings. The average M2/GDP ratio hardlychanged during 1971-74.1] Domestically, the state agencies were a conduit forchanneling funds to finance investment, with the banks assuming a very minorrole.

5.7 Of all three countries in Latin American, Argentina's financialsystem was by for the most repressed. Banks merely transmitted the public'sfinancial savings to the Central Bank and confined themselves to lending out

.1/ An alternative view prevalent in some quarters was that M2/GDP in factincreased because of an artificial bloating of money as a result ofconversion of physical assets into money for the purpose of capitalflight.

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 -3.941CHILE -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 -6.49ZURUGUAY 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 2.711CHILE 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 5.288URUGUAY 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 bankssecure deposits for the Central Bank, which then allocated them to differentsectors according to predetermined priorities. Thus, there was no linkagebetween 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, withthe result that the financial sector shrivelled greatly. (For a fullerdiscussion, see T. Balino, 1988.) The M2/GNP and M3/GNP ratios declinedsharply. Shrinkage of the financial sector was also caused by the issuance ofindexed government bonds which competed with bank deposits since they were abetter hedge against inflation (T. Balino, 1988).

5.8 With Uruguay's macroeconomy in a precarious condition, the financialsector was distorted. Interest rates on both bank deposits and loans werenegative in real terms (V. Galbis, 1981). The only redeeming feature of thefinancial system was the impressive growth of financial assets in the form oftreasury 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 byushering in a new development strategy with a basic thrust toward freermarkets. Following this broad framework, the Chilean authorities emphasizedthe primacy of private enterprise, openness to the world economy and marketdetermination of all prices (interest rates, commodity prices and exchangerates) except perhaps wages. Insofar as the financial markets were concerned,the banks were denationalized. Reserve requirements were scaled down overfive to six years to 4% of savings and time deposits and 10% of demanddeposits. Preferential credits from the Central Bank were drasticallycurtailed, and the refinancing rate on the remaining credit was raised to themarket level (V. Galbis, 1981). All categories of financial institutions(banks, development banks and other financial intermediaries) were permittedto compete for any type of business, and access to the financial sector wasmade progressively easy for new entrants. Capital controls were effectivelyliberalized in 1979. Until late 1981, capital flows of less than two yearswere allowed only to finance foreign trade operations, and medium-term capitalinflows were subject to reserve requirements. Halting progress was made indismantling capital controls because of the fear that a massive inflow ofoutside capital induced by high interest rates would be destabilizing.However, despite restrictions, capital flowed in on a large scale. Between1977 and 1979, net capital inflow was estimated around US$8 billion (G. Fort,1985) and it increased even further in 1981 when further liberalization tookplace.

5.10 Financial liberalization was accompanied by equally sweeping refornin most other spheres of the economy. Domestic prices were deregulated, andtariff and nontariff barriers to trade were eliminated. Over 5 yearsbeginning in 1974, the average tariff was scaled down from 90% to a uniform10%. This was followed by adoption of strong stabilization polices, reducingthe fiscal deficit which had aggravated inflation, and by adjusting thenominal exchange rate to restore the balance of payments equilibrium. Thepeso 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 towardreform. Interest rates and capital movements were unfettered fromrestrictions, in contrast to Chile, where this was done over five years. InArgentina, interest rates weria allowed to be determined by market forces; theonly 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 toensure that financial intermediaries adjusted smoothly to the competitiveconditions unleashed by deregulation, reorganization and mergers, and severalnew institutions were created. Entry restrictions were relaxed gradually.The adjustment policies, with an accent onI eliminating the balance of paymentsdisequilibrium, effected a steady exchange rate depreciation through anannounced schedule for removal of reserve requirements on foreign loans.However, adjustment in the fiscal deficit and domestic credit was less than inChile, causing persistently high inflation and concomitant depression of realinterest rates.

5.12 As regards other aspects of liberalization in Argentina, there was astop-and-go approach to price controls: prices were deregulated in 1976 andthen recontrolled in 1977. The exchange rate was initially unified with asharp devaluation accompanied by a reduction in tariffs and taxes ontraditional exports. However, some relics of protective tariffs remaineduntil 1979.

5.13 Argentina's financial reform experiment differed from Chile's orUruguay's (and, for that matter, any other country's) in that it reintroducedeven more pronounced and stringent intervention in 1980 when its financialmarkets were on the brink of collapse. As the solvency problem of some banksfirst exploded, the Central Bank offered its credit to these banks to meet thecrisis. Later in 1980, when the size of bad debt grew large, the Central Bankannounced its readiness to advance credit to the financial institutions havingbad portfolios for a period longer than their deposit maturities so that theycould in turn extend the maturity of their doubtful loans. With the disparitybetween enterprise and household liabilities and real assets widening in theface of high real interest rates, there was a complete volte face 1982 fromfinancial reform for a limited time when the authorities generated, as adeliberate policy, negative real interest rates to facilitate scaling down ofprivate debts. The financial sector was segmented into three parts. Thefirst was a regulated one having deposits of less than 90-day maturity, onwhich a 100% reserve requirement was imposed. These institutions were givenCentral Bank credit at a concessional 5.6% to 6% rate to enable them torefinance their existing debts. The other segment, a free-rate segment withnontransferable term deposits with maturities of over 90 days, could pay anyinterest rate provided the volume of deposits they could garner did not exceeda proportion each institution held on June 30, 1982; this proportion variedfrom 6% to 20% over 3 months. The third segment consisted of institutionswith indexed deposits carrying a free interest rate. Though no limit wasimposed on these deposits, they attracted 100% reserve requirements. All thiswas 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.

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81

5.14 Uruguay's reform was a cross between the gradual intervention and thefull and complete deregulation as in Chile and Argentina. Along with aflexible exchange rate policy designed to attain a sustainable balance ofpayments, the authorities began to unravel the ceilings on interest rates instages, the first in April 1976 when uniform ceiling of 62% replaced allexisting ceilings on liabilities and assets of the financial institutions.When these ceilings could not ensure positive interest rates in the face ofgalloping inflation, the ceilings were raised to 90% in November 1977; reserverequirements were also gradually reduced in 1978 (after having been raised in1977), partly for monetary policy purposes, partly for assisting theallocative credit programs, and also for relieving credit stringency arisingfrom constraints on foreign borrowings (V. Galbis, 1981).

5.15 On other fronts of liberalization, Uruguay abolished price controlsby end-1979 but progress in regard to commercial policy reform was much lessthan in Chile and Argentina. Import quotas were eliminated in 1975 along withtaxes on traditional exports, but direct subsidies were retained on non-traditional exports until 1979. Tariffs were reduced by 50%, though they werestill high at 150%. Since tariffs were related to prices, often higher thanthe landed prices induced by the appreciating real exchange rate, realizedprotection was much higher than the nominal protection.

3. Impact of Financial Reforms

5.16 This section will concentrate on the impact of financial reform onthree principal aspects of the financial systems in the three countries: thegrowth of financial assets, level and integration of interest rates, and theemergence of nonperforming loans. The changes in other areas will bementioned 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 oftotal financial assets (which included paper issued by banks, developmentbanks and financiaras) to GNP more than doubled between 1975 and 1982. Evenmore important, financial assets other than M2 as a proportion of totalfinancial 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 financialcrisis, but the ratio of change in financial assets (M2) to private savingshowed a different trend. After rising to 1.0 in 1979, it fell and remainedat 0.27 in 1986, a level even lower than it had in 1979 (Table 23), but theM3/GDP ratio showed a sustained increase. (This figure is based on VelascoStudy (1988) and differs from that in Table 23. It seems more reliable sinceit is from a Central Bank source.) These movements had two importantimplications: one was that the relative importance of nonmonetary financialassets increased after financial reform, and the other was that the extent offinancialization 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 21.82CHILE - 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 0.782CHILE - 0.791 1.291 0.571 0.643 0.572 0.404 0.371 0.637 0.140 -0.088 0.386 0.293 0.213URUGUAY 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 0.897CHILE - - - - - - 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 offinancial reform on the banking systems were exaggerated by the inflow offoreign funds, both on account of banks an,d the nonbank public, whichbolstered the deposit liab-ilities of banks. Considering that this level offinancial assets could rise or fall depeneling on the external conditions, thegrowth in financial assets; could not be seen as implying a long-term trend inthe financial intermediation process. Perhaps a more enduring changefollowing financial reform was seen in the greater role of the financialinstitutions in mobilizing savings than before liberalization. Earlier, theGovernment was the main instrument to mobilize and channel savings. Thatfunction was subordinated to that of the financial institutions, with theGovernment's resources declining and its reliance for funds placed on thefinancial system.

5.18 While the process of financial intermediation became vigorous, theaverage maturity of financial instruments shrivelled. Longer-term assetslanguished. They accounted for 54% of total assets in 1975, and for only44.4% 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 wereunrelated to the rate of return on investments" (Meller and Solimano, 1980 asquoted by A. Velasco, 1988).

Argentina

5.19 In the initial flush of reforms, the Argentine financial systemreacted well to market incentives of higher interest rates and competitiveconditions. The M3/GDP and M2/GDP ratios increased substantially during197779 (Table 22). The difference between M3 and M2 clearly demonstrates thatnew nonmonetary financial instruments emerged, partly as a consequence of thediversification of the activities of banks and partly due to the setting up ofnew institutions such as finance companies. Commercial banks almost doubledby 1979, but what was even more impressive was the increase in the proportionof saving in the form of financial assets. Both the ratios of change inM2/private saving and M3/private savings increased much faster immediatelyafter reform (Table 23). This is all the more significant when thefinancialization of savings is seen in the context of a decline in privatesavings in the same period. The impact of financial reform on financialintermediation was magnified by the substantially increased inflow of foreigncapital at the outset of financial liberalization with the opening out of theeconomy and removal of all restrictions on capital movement. Between 1977 arLd1980, capital inflow was of the order of $3.2 billion (R. Fernandez, 1985).

2/ This was somewhat a different explanation from C. Diaz Alejandro andE. Bacha (1982), who posit an inverse relationship between financialasset 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 11.61C8ILE 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 14.62URUGUAY 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 5.8XCHILE 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 7.61URUGUAY 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 SURUGUAY 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 86.6CHILE - - - - 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 1CHILE 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 COURUGUAY 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.

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Uruguay

5.20 Liberalization influenced the growth of financial assets in Uruguayin a most beneficial fashion. The ratio of M2/GDP rose by 10% between 1976and 1979 and continued upward until 1982. The ratio of change in financialassets (M2) to total domestic savings grew from 0.9 to 1.28 in 1979 and to1.32 in 1982, reflecting a healthy trend in financialization of savings.Domestic savings increased during this period by 20%, which meant that thedegree of financialization of savings was even larger than was reflected inthis ratio. However, in Uruguay too, as in Chile and Argentina, the spurt inthe M2/GDP ratio was induced by the dollarization of the financial system, asis evident from the fact that foreign-currency-denominated deposits as aproportion of total bank deposits increased from 0.48 to 0.67 between 1976 to1982 (J. de-Melo and J, Tybout, 1985). The infusion of foreign currencydeposits began in 1976 when the reform policy was initiated, but itaccelerated substantially when the tablita, a preannounced devaluationschedule designed to break pressures for further devaluation was introduced asthe 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 increasedfaster than the inflation rate, thereby ensuring positive real interest ratesfor the first time in recent years. From 1974, the real interest rates ondeposits were positive until 1984 (in a range of 1% to 17%), and loan rateswere substantially higher in both nominal and real terms. Despite growingcompetition among banks and nonbanks following liberalization, theoligopolistic nature of the banking system and the bank holding structurecontinued.

5.22 High nominal interest rates were expected after reform, but they wereeven higher than LIBOR after adjustment for devaluation. This wasunderstandable for the period until 1979 because capital controls were inexistence and they were quite effective. But the higher level of domesticinterest rates after 1979 when capital controls were progressively dismantledand when the parity conditions were subject to a market test remained somewhatof a puzzle. Explanations for this phenomenon include imperfect substitutionbetween domestic and foreign financial assets, costliness of arbitrageactivity by banks, and market segmentation, but none provides a satisfactoryanswer for why parity conditions did not hold in Chile or why domesticinterest rates rose so high. The peso/dollar spread was in favor of Chileuntil 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 yearsafter 1976, positive real interest rates obtained only in 1977 and againduring 1981-83 (Tables 21-I and 21-II). The ex Rost peso/dollar interestspread 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) thanthe foreign rates.

Uruguay

5.24 The banks' nominal deposit and loan rates surged in Uruguay, but thelatter recorded a much higher rise than the former (Table 21-I and 21-II andII). With rapid escalation of inflation, bank deposit rates turned negativein real terms until 1980, while the real loan rates have remained positivesince 1976. As in the case of Chile and Argentina, the ex Rost peso/dollarinterest spread indicated that both nominal and real domestic interest rateswere higher than foreign initerest rates most of the time. This phenomenonwill be analyzed in depth later in connection with the linkage ofstabilization policies and financial reform policies.

(c) Nonperforming Loans

Chile

5.25 Since the financia:L system was liberalized, the single most importantdevelopment in Chile was the staggering debt accumulated by the privatesector. The ratio of debt to the banking system shot up from 5.0% of GDP in1974 to 61.7% in 1982 (A. Velasco, 1988). Such sharp growth was fueled byoptimistic expectations generated in the initial stages when Chile achievedrapid growth. Once the debt got going, it developed its own momentum, spurredby the intrusion of other factors such as the dominance of the financial andmanufacturing conglomerates. Banks lent to the firms belonging to the ownersthe banks, and such loans constituted around 20% of the banks' portfolios(Luders, 1985; D. Hanna, 1987; A. Velasco, 1988). Lending on such a scalewhen interest rates were excessively high and the peso overvalued madeproduction activities highly unremunerative and brought widespreadbankruptcies. As a result, and the banks' portfolios soured. The demand fornew loans should have declined, but instead it rebounded. Harberger (1985)described it as "a false demand" consisting of rollover of essentially badloans and capitalization of interest estimated to be around 72% of outstandingpeso loans by end-1982 (A. Velasco, 1988). As a result, loan default as aproportion 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 measuresranging from outright bail-out through the provision of emergency loans andsubsidized credit, purchase of risky loans by the Central Bank, and a host ofother rescue measures. All these resulted in an enormous increase in CentralBank financing of commercial banks. Between June 1982 and June 1985 suchfinancing 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 naturallyfomented macroeconomic disturbances, since market participants interpreted itas abdication of the authorities' responsibility to maintain stability in theeconomy. The stabilization policies lost all credibility.

Argentina

5.27 The genesis of the nonperforming loans and their rapid expansion inArgentina 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 forfirms to continue production. The situation was accentuated by the highgearing ratios of firms, which magnified the impact of high interest rates ontheir profit margins (A. Petrei and J. Tybout, 1985), and also by theirdistress borrowing which raised their indebtedness to banks. As a result, badand doubtful debts as a ratio of total bank loans accelerated from a mere1.95% in 1975 to 9.13% in 1980. Here again, as in Chile, the Central Bankplayed a crucial role by injecting credit to help the crisis-affected banksthrough a refinancing subsidy. Later, the authorities totally reversed thefinancial 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: onewas the loss of credibility of the financial reform policies, and the otherwas the loss of credibility of the stabilization policies. The latter wasevidenced by the fact that between 1979 and 1984 the Central Bank's claims onfinancial institutions as a proportion of total Central Bank liabilitiesrebounded from 4.40% to 45.0%; it once reached 63.52%.

Uruguay

5.28 The basic causes of an increase in nonperforming loans in Uruguaywere high interest rates and the overvaluation of the real exchange rate as inChile and Argentina. The domestic interest rates could not converge with theinternational rates, and in fact the spread generally remained unchanged.Because of the dollarization of the economy and the encouragement of theauthorities, the productive sectors borrowed heavily in dollars to buymanufacturing equipment. The adverse impact of this development was notassessed properly by banks, which continued to finance the purchase ofoverpriced assets. Inevitably, the Central Bank injected its credit into thesystem.

5.29 The Central Bank intervened in 1981 by offering subsidizedrefinancing facilities to banks whose conditions varied according to whethertheir loans were denominated in pesos or foreign currency. The Central Bankalso provided assistance in buying the loan portfolios of failing banks andthe nonperforming loans of other banks. All these increased Central Bankcredit and therefore increased monetary expansion with an adversemacroeconomic outcome similar to that in Chile and Argentina.

4. Adiustment Policy Implementation And its Linkage with FinancialLiberalization

5.30 Adjustment policies employed to deal with macro imbalances in theshort run need to be eased into liberalization programs since they areconcerned with gradual elimination of structural rigidities in the economywhich impede efficient resource allocation and factor use. These two sets ofpolicies interact with each other, and unless they are mutually reinforcing,

92

neither can succeed or acquire credibility.3j Stabilization policiesimplemented in the Latin American countries will be viewed from thisperspective in the subsequent discussion.

5.31 The main macro imbalances facing these countries, surging inflationand the debilitating external account deficit, cried out for immediateattention, though the relative urgency of each varied from country to country.The stabilization policies were implemented in two stages: first, they werefocused on curtailing inflation drastically through both monetary contractionand reining in the fiscal deficit (V. Corbo, J. de Melo and J. Tybout, 1985).However, the anti-inflationary measures by themselves could not haveeliminated the external account deficit. Devaluation became inevitable toswitch expenditures from domestic to foreign markets. Only in Uruguay wasdevaluation combined with other emphatic measures to develop nontraditionalexports.

5.32 The first phase of stabilization commenced in Chile in 1974 and inArgentina and Uruguay after 1976. With policies in full swing, the rate ofinflation 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 to44.6% from 51% in 1976. Inflation remained stubbornly high (Table 15).

5.33 The overall balance of payments position improved in all threecountries. The fiscal deficit in Chile was almost eliminated in 1978, downfrom an average of 10.6% during 1971-73 and eventually there was a surplusbeginning in 1979; in Argentina, the fall was substantial--from 12.5% in 1976to 3.8% of GDP in 1978--though not as sharp as in Chile. In Uruguay, thefiscal deficit was within tolerance limits by the standard of Chile andArgentina at 3.5% of GDP on the eve of the reform. It dropped to 0.9% by theend of 1978 and was eliminated in 1979. (Table 18)

5.34 As expected, the stabilization policies directed at clamping down oninflation through reduction of aggregate demand had adverse consequences interms of a shortfall in output, increased unemployment and reduction of realwage rates. Chile suffered most, with a negative GDP growth rate of 13% in1975, partly a result of stabilization policy but largely a consequence ofworld recession. Still, the average growth rate of its GDP was 1.9% during1974-78, higher than the bare 0.7% preceding adjustment. In Argentina, GDPfell sharply to almost zero initially but recovered after 1977. Uruguayrecorded a somewhat higher growth rate of 4% (Table 16). The impact ofstabilization policies on employment and wages was severe, its extent varyingfrom 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 wasstill higher than in the prestabilization period. The real wage rate indexfollowed the same trend, declining from 98 to 69 in 1976 and rising slightly

j/ L. Sjaastad (1983), for instance, argued that the credibility of theliberalization program came to depend upon the success of stabilizationpolicies. However, the reverse was also true: the credibility of thestabilization policies also depended on the success of the financialreform policies.

93

to 82 in 1978 (V. Corbo, J. de Melo, J. Tybout, 1985). In Argentina, theunemployment rate increased only slightly between 1975 and 1978, and realwages 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. Sinceadherence to the same strategy would have meant more of the same, it was notpolitically feasible in the face of high and unabating unemployment. InArgentina, the stabilization strategy was therefore modified to accommodateemerging political imperatives. Since inflationary pressures and devaluationwere thought to be linked, it was believed that inflationary expectationscould be lessened if devaluation of the domestic currency were planned andgradual. This consideration paved the way for adoption of a preannouncedexchange rate, or what came to be called the tablita. As Sjaastad (1983)pointed out, the rationale behind it was that "... the rate of devaluation wasintended to influence the rate of inflation, rather than vice versa. Thus theexchange 'tables' were intended to convey information concerning the futureevolution of the price level rather than merely providing a more or lessstable real exchange rate."

5.36 The immediate impact of the shift to this new system of planneddevaluation and away from the earlier emphasis on containment of fiscaldeficit and monetary contraction appeared in a reduction in the cost ofraising funds abroad in relation to the cost of domestic funds. Interest ratearbitrage became profitable in all three countries (Appendix Tables Chile 3,Argentina 3 and Uruguay 3). In the earlier period, when anti-inflationarypolicies were combined with financial liberalization, real interest ratesrebounded, and though they occasionally became negative as in Argentina andUruguay, they tended to remain very high. With the adoption of a tablita asthe main instrument of stabilization policies, interest rates came underfurther upward pressure because of expectations that the resulting exchangerate levels would be unsustainable and even further exchange rate changesbeyond what the tablita indicated would be required. At the time the tablitawas introduced, Chile had considerable restrictions on its capital account,unlike Argentina and Uruguay where such controls had already been done awaywith. Chile eliminated capital control in the belief that a freer inflow offunds from abroad would help bring down real interest rates. However, farfrom such a denouement, the high interest rates persisted. The tablitainduced inflows increased absorption and drove up the prices of nontradeables,thereby raising the real exchange rate. Though inflation went downsubstantially as an initial reaction to these measures, inflationaryexpectations resurged as capital inflows raised monetary aggregates. Thismade market participants believe that the exchange rate was unsustainable, andconsequent expectations of devaluation edged real interest rates up indomestic financial markets. Two other factors made the situation even worsein Chile, First, the real wage rate rose because of the way wage indexationwas contrived (V. Corbo, 1985); second, the tablita worked at cross purposeswith the export-based strategy of generating growth by trade liberalization(V. Corbo, 1985). Thus, the costs which normally figure in the profitcalculus of businessmen, viz., the appreciated exchange rate, high realinterest rate and a high wage rate, contributed to business failures andjeopardized both the financial reform and adjustment policies (V. Calbis,1988).

94

5.37 A similar explanation about the failure of stabilization reformpolicies holds, more or less, in the case of Argentina. The devaluationschedule no doubt helped pare down inflationary pressures and encouraged theinflow of foreign funds. However, the fall in the inflation rate was neitherprecipitous nor large enough to prevent the peso's real exchange rate fromappreciating. Furthermore, the persistence and widening of the fiscaldeficit, which in Chile and lJruguay was not only eradicated but alsotransformed into a surplus, heightened market participants' expectations thatthe exchange rate changes, preplanned though they might be, would fail tomaterialize. 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 creditdemand remained unsatisfied), upward pressure on the market rates of interestincreased.

5.38 Uruguay's experience with stabilization was no different from Chile'sand Argentina's, except that Uruguay's difficulties were exacerbated by itsclose economic and trade links with Argentina and Brazil, which were devaluingfrequently and substantially. Uruguay did not keep pace but devalued in smallsteps (J. Hanson and J. de Melo, 1985), thereby slowing export growth. At thesame time, the Government's deficit expanded. These two factors, the renewedfiscal deficit and the constraint emanating from the decline in exports,induced large recourse to foreign borrowing to shore up internationalreserves. As a consequence, devaluation expectations were fueled, furtherescalating domestic real interest rates.

5.39 The question to ask is why stabilization policies in the SouthernCone countries did not succeed to the extent anticipated by policy makers andeconomic rationalizers. The high level of real interest rates in thesecountries depressed domestic investment by squeezing the profit margins offirms. This in turn damaged the financial system, particularly banks (themain lending agencies), and brought on a widespread financial crisis. Themost commonly offered explanation for the continuation of high real interestrates and the consequent larger spread between rates on peso/dollar depositsand loans, was the exchange rate policy. The tablita generated capitalinflows which caused appreciation of the real exchange rate and expectation offurther exchange rate depreciation beyond the preannounced schedule. Thiscontributed to the continuation of high real interest rates, but thisexplanation is more a truism than a causal factor. Those who firstrationalized preannounced exchange rates as an instrument of anti-inflationaryadjustment policies were fully aware that: they would induce short-run capitalinflows and consequent appreciation of the real exchange rate (C. Rodriguez,1982). What was not realized, however, was that the effect of thepreannounced exchange rates would be prolonged, not transient. It istherefore pertinent to ask why the expected did not materialize and thecapital 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 thetablita policy and their long duration is the inconsistency of themacroeconomic 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

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D. Mathieson, 1988). By inconsistency was meant a large fiscal deficit andcredit expansion and a rise in the wage rate, which together nullified theeffects of the tablita. However, the fiscal deficit was not much of a problembefore or after tablita except in Argentina; Chile had a surplus in 1977-78,and Uruguay almost balanced its budget (Table 18). Monetary expansion was notan independent factor, as the source of it in these countries was the fiscaldeficits (in addition to inflow of foreign capital). It therefore seems thatneither the fiscal nor the monetary policy could be blamed for the perverseeffects of the preannounced exchange rate policy, in Chile and Uruguay at anyrate. 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 inArgentina, it rose as a reaction to a burgeoning fiscal deficit. The realwage rate did not create any particular difficulties in Uruguay: in fact, itdeclined.

5.41 Another inconsistency referred to in the context of the failure ofthe tablita was its lack of credibility. In support of this argument, Corboet al. (1985) pointed to Argentina, where the spread between domestic interestrates and foreign interest rates widened as doubts began to mount about thesustainability of the tablita. At the beginning of 1979, this spread tendedto narrow when confidence in the tablita was highest, but it startedincreasing when confidence waned with a steady shortening of the remainingperiod of the devaluation schedule. In Uruguay, the credibility argument wassomewhat modified to suggest that, in addition to the exchange risk, loansdenominated in dollars were imperfect substitutes for loans denominated inpesos (J. Hanson and J. de Melo, 1983; Fernandez, 1985). However, thisrationalization is not convincing. For one thing, if the vaguenesssurrounding the devaluation schedule (creating uncertainty in the minds of themarket agents about the sustainability of the exchange rate) were all thatmattered, then one needs to provide an equally convincing rationale why inUruguay, where no such ambiguity shrouded the tablita. the spread betweendomestic and foreign interest rates was virtually unaffected. To be valid,any analytical explanation of such occurrences has to be sufficiently generalto explain other situations. Furthermore, while the argument of imperfectsubstitutability between domestic assets and foreign assets might be valid, ithas a very tenuous link to exchange rate risk. The degree of substitutabilitybetween domestic and foreign assets is a function of several variables such asinstitutional rigidities in domestic markets, absence of long traditions,familiarity with market-related transactions, and the exchange risks. Apartfrom this, the argument of imperfect substitutability of assets runs counterto the accepted premise that tablita-induced capital inflows, by facilitatingthe appreciation of the real exchange rate, resulted in high real rates ofinterest.

5.42 The foregoing discussion shows clearly that the unanticipatedconsequences of the tablita in Chile, Argentina and Uruguay and its impact ondomestic real interest rates cannot be ascribed merely to inconsistencies inmacroeconomic policies, though lapses such as the lack of control on thefiscal 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 ofoverriding importance, their effects should have been to lower real interestrates rather than raise them or maintain them at high levels. As Galbis has

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persuasively argued, the consequences of macroeconomic policies, inconsistentor counterproductive though they were corLsidered to be, "should have led,under competitive conditions, to a decline in the demand for credit on thepart of the firms, and also to a more selective approach in the supply ofcredit by the financial institutions, because of the higher risks involved inlending during a cyclical downturn. In these circumstances, the rate ofinterest should have tendled to decrease, especially after the authoritiesabolished all capital inflow restrictions, a measure which was directlyintended to increase the supply of credit and thus to reduce the domesticrates of interest to the international level." (V. Galbis, 1986). There aretherefore reasons in add:Ltion to inconsistencies in macroeconomic policies forthe high interest rates. Several authors have offered varying explanations insupport of their particular viewpoints, but none completely resolves theriddle. The actual situation was much too complicated to lend itself to aclear and definitive conclusion on the factors making for the high realinterest rates.

5.43 Among the medley of hypotheses about the high level of real interestrates (see, for summary of some of the hypotheses, A. Velasco, 1988), twowhich can be applicable in varying degree to these three countries should besingled out. The first is linked to the oligopolistic structure of thebanking system, particularly in Chile and to some extent in Argentina, and tomarket imperfections. When financial liberalization was going full steam,with the concomitant restoration of the holding company structure to thebanking system, groups of industrial and trading firms closely linked withfinancial institutions constantly exerted fierce pressure on the latter toappropriate 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. Theprofitability of the groups' productive operations could not have beensustained for long in the face of very high interest rates. Yet it happenedthat, because of the interlinking of ownership, the banks continued to lend athigh interest rates to the borrowing groups. This accelerated the accumula-tion of arrears of bad and doubtful debts but did. not deter banks fromaggressively competing for deposits at still higher rates following abolitionof all controls on their operations (V. Galbis, 1986; C. Diaz Alejandro, 1985;V. Corbo, 1985 and D. Hanna, 1987). The oligopolistic structure was not asprominent a feature of Argentina's financial system, though the residue ofmonopoly power which alLowed banks to appropriate monopoly rent in the form ofhigher interest rates was not insignificant (T. Balino, 1988; D. Barandiaran,1988). To some extent, the level of interest rates reflected a large riskpremium on loans given to newly emerged clients whose credit background wasunknown and who, in securing new avenues of profit sharing, were not dauntedby the riskiness of projects so long as the expected returns were thought tobe high. As Stiglitz and Weiss (1981) have argued, in the event of bankruptcysuch borrowers have nothing more to lose than the collateral against loans ifthe 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 ishas to do with distress borrowing, implying that the borrowing firms underfinancial stress and with serious cash-flow problems will borrow at anyinterest rate rather than sell assets to meet losses. Distress borrowing wasmore typical of Argentina: "During the late 1970s, firms appear to have

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substituted dollar debt for peso debt, keeping their overall leverage stable.But beginning in 1980, when earning rates fell sharply, firms steadilyincreased their reliance on debt finance so this year and thereafter, some ofthe increase in firms' financial riskiness many have been due to distressborrowing. The beginning of the upward leverage trend corresponds to theemergence 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 ofPetrei and Tybout, when he found that the firms with high ratio of debtamortization plus interest prepayment to their self generated funds came underjudicial surveillance (G. Dreizzen as quoted in T. Balino, 1988).

5.45 While it was recognized that the financial crisis in these countriesemanated from wrong and inconsistent macro policies, the reverse questionwhether financial sector disequilibrium following financial reform alsoadversely affected the macroeconomic outcome is rarely asked. If realinterest rate reached intolerable limits because of the oligopolistic bankingstructure or distress borrowing, with the damaging consequences for thefinancial systems, it could be due to the initiation of financial reforms inthe imperfect financial markets in the Southern Cone countries. Thereforefinancial liberalization, far from leading to an equilibrium level of interestrates, had a severe adverse impact on profitability of firms and generated adisastrous financial crisis. This in turn necessitated injection of CentralBank credit into the system when macroeconomic imbalances were serious. Thus,the inappropriateness of the liberalization design under an imperfectfinancial structure reinforced inconsistencies in macroeconomic policies andaggravated the economic and financial disequilibrium.

5.46 A more rewarding approach to stabilization policies might have beento pursue a conventional stabilization policy, vigorously adapting it to localconditions in the long-term perspective of a liberalized economy. After pricestability and external equilibrium--essentially short-term goals--areachieved, a beginning might have been made in gradually phasing out theinterventionist regime. It should be recognized that there is nothingbasically wrong with government intervention per se when market failures inthe financial and product markets are pervasive and pronounced. Thedifficulty lies more with the manner in which intervention is implemented.Experience has shown that in most countries intervention is arbitrary and hasno predetermined plan or criteria. Government intervention can be market-creating or market-destroying; what is required is to shift intervention awayfrom the latter. But dismantling it altogether and at one stroke is to offerhostages to very repressive institutional agents the weakening or eliminationof which was the principal objective of financial liberalization policies.This was also the reason liberalization became counterproductive, insofar asit took away the bite from stabilization policies despite their allegedshortcomings.

5.47 Financial reforms unsuited to economies with imperfect marketstructures and inconsistencies of macroeconomic policy were the most basiccauses of the high real interest rates. Failure to put in place a wellconceived and well-organized supervisory apparatus capable of wieldingeffective prudential control over the banking system during liberalizationmade the situation worse by allowing banks to raise interest rates as theypleased. As Corbo (1985) rightly pointed out in the context of Chile, '...the

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deregulation of domestic financial markets gave commercial banks and financialinstitutions too much freedom. The financial intermediaries took undue risksby inadequate evaluation of their loans as well as by concentrating theirloans in clients connected to the banks through cross-ownership. And withoutappropriate supervision, Lntermediaries in financial difficulty were able toincrease interest rates just to attract new deposits and make up the shortfallon interest payments to depositors created by their nonperforming loans." Itwas this lack of prudential regulation of the financial system which led banksto misuse the explicit an-d implicit deposit insurance to raise deposits byfair means or foul to conceal their nonperforming loans and eventually causedthe financial crisis. The difficulty lay thus not so much "in theinconsistency between the proclaimed reliance on the free market mechanism andthe de facto treatment of the financial intermediaries" as in notcomprehending the paramount importance of closely monitoring and regulatingthe operations of the sensitive money-creating institutions. Here again, therent-seeking behavior of financial intermediaries should not be attributed todeposit insurance as such but rather to the mistaken notion that financialliberalization meant dismantling the most essential type of prudentialregulation.

5. Financial Liberalization Experience in Southern Cone and Asian Countries:A Comparative View

5.48 Financial liberalization in the Southern Cone countries in LatinAmerica went awry for several reasons. First of all, financial liberalizationwas initiated in an unstable macroeconomic environment which was made evenworse by inconsistencies in macroeconomic policy. In addition, the wayfinancial reforms were designed and implemented contributed to financialdisequilibrium and thus rmagnified macroeconomic disturbances. Second, it wasnot realized that financial liberalization in imperfect and oligopolisticfinancial markets had certain inherent limitations. Therefore, when controlon interest rates was eliminated and the operations of financial institutionswere freed from government intervention, the outcome was not as expected.Real interest rates were extremely high in relation to marginal rates ofreturn on capital in all the three countries, Chile, Argentina and Uruguay.As a result, firms were involved in financial difficulties which in turncreated a crisis in the financial system and engulfed their economies in aneconomic crisis. Third, abolition of restrictions on the capital account wereclearly premature. With macroeconomic imbalances as severe as ever (Chile,however was an exception) freedom of capital movement proved to bedisequilibrating insofar as it generated expectations of further currencydevaluation, which in turn raised domestic interest rates even further.Finally, the crucial importance of supervision of the financial institutionswas virtually overlooked. Financial liberalization was mistakenly equatedwith elimination of the most essential regulations required to maintainsensitive credit institutions on an even keel. The latitude so given was usedby the oligopolistic banking firms to jack up the interest rates and intensifya scramble for new deposits even when loans were failing.

5.49 Of the five Asian countries, the experience of the Philippines andIndonesia could be considered to be close to that of the Southern Conecountries. The Philippines had no capital controls to speak of, and interestrates were freed, though over time. The country had to face serious problems

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of high interest rates leading to a profit squeeze and consequent enlargementof the nonperforming loans. The Central Bank's actions, too resembled thosein the Southern Cone countries inasmuch as the infusion of central bank creditto bail out failing financial institutions interfered with stabilizationpolicies directed toward curtailing inflation and restoring the balance ofpayments. Indonesia's financial reform strategy, though not fully comparableto that of the Southern Cone countries, retained its liquidity credit programswith subsidized credit almost intact (despite the proclaimed objective ofphasing it out) with similar but less severe consequences. Among these werethe debilitating volume of bad and doubtful debts which followed in the wakeof high and volatile interest rates, and destabilizing capital flows withconstant expectations of devaluation put upward pressure on domestic interestrates. But the financial crisis did not reach the Latin American proportionsonly because the authorities could lessen the impact of high interest rates onthe industrial sector by enlarging liquidity credits and supporting thefragile banks. The economy weathered the storm but could not surmount it.

5.50 In contrast, Korea, Malaysia, and Sri Lanka came out bruised asseverely but not as battered as the Southern Cone Countries and thePhilippines. Of the three, Korea and Malaysia can be considered to have comeout well after reforms. Korea passed through adverse macroeconomic conditionsbut made flexible and pragmatic adjustments to the main elements of its reformstrategy. When the high level of real interest rates, following reform madethe business sector financially vulnerable, the Central Bank reduced nominalinterest rates even though inflationary expectations were high. Korea keptits capital account under a tight leash and so was not confronted withdestabilizing capital flows either inward or outward. In short, its approachto financial reform was gradual rather than sudden, and its sequencing wastailored to the exigencies of the changing macroeconomic situation. Besides,it did not dismantle the directed credit programs all at once, and as aconsequence the impact of high real interest rates on investment wasmoderated; but once the economy went into an upswing, directed credit waseased out. The problem of nonperforming loans was quite serious, but it wascontained because de facto control of the banking system remained, andsubsidized credits were made available by the Central Bank to enable banks tobear the burden of nonfunctioning loans.

5.51 Malaysia too was free from serious disturbances, but the reasons weredifferent from those in Korea. For one thing, Malaysia's deregulation hadbeen narrow in scope. Reform eliminated only ceilings on bank deposit rates.However, this made little difference to the determination of interest ratessince foreign factors played a significant role. Malaysia had an open capitalaccount, but capital flows did not prove to be disequilibrating because theexchange rate was stable. Of course Malaysia had its share of nonperformingloans, but their size was limited because trained and conservative bankmanagement and efficient, effective and pervasive bank supervisory machineryminimized the default rate. But the real reason was that Malaysia persistedwith its selective credit policy, which softened the impact of high interestrates on the business sector. In fact, through a measured and gradualapproach to financial liberalization, Malaysia even turned around itsmacroeconomy even though it was afflicted by external shocks. Finally, theMalaysian economy was accustomed to functioning in competitive conditions evenbefore reform, unlike the economies of the Southern Cone countries.

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5.52 In Sri Lanka's case, financial liberalization was gradual. Itreduced intervention in interest rates, selective credit, etc., but neverreally eliminated it. In particular , the selective credit program covered alarge part of the total banking system's credit ,which to some extent couldcontain the problem of nonperforming loans.

5.53 It is clear from the comparative picture of the Southern Cone andAsian financial liberalization experiences that abrupt removal of governmentintervention in the midst of pronounced macroeconomic instability, imperfectand oligopolistic financial structures and a completely open capital accountdoes not yield optimal results.

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VI. LESSONS FROM FINANCIAL LIBERALIZATION

6.1 This survey of financial liberalization has focused on theexperiences of five Asian countries and drawn attention to events in theSouthern Cone countries of Latin America in regard to the implementation oftheir reform policies. This section outlines the lessons that may be learnedfrom these countries' experiences.

6.2 One of the most important lessons to be drawn from financialliberalization across countries is that price stability and, more broadly,macroeconomic stability, is the linchpin of successful liberalization, not thederegulation of interest rates per se, especially when the countriesundergoing financial reforms have shallow financial markets. The experiencesof the Philippines and Malaysia and the Southern Cone countries underscore theimportance of price stability in two different ways. In the first twocountries, the level of inflation was a determining factor in attainingpositive interest rates. The adjustment in real interest rates lagged wheninflation was declining, although the interest rates were fully liberalized.The resulting high interest rates may lead to widespread insolvency of firmswith high gearing ratios, as in Indonesia, or to an economy on a downwardslope, as in the Philippines. In Korea, however, although interest rates wereadministered by the Government, interest rates were substantially positive andstable because of price stability and the flexibility with which nominalinterest rates were adjusted according to the movement of inflation. At theother extreme, in the Southern Cone countries inconsistent macroeconomicpolicies rendered their economic system unstable and vulnerable to shocks, andtheir economies did not prove congenial to the whiff of financialliberalization policies. The resulting adverse expectations led to unsustain-ably high real interest rates.

6.3 It is also clear that financial liberalization, if not properlydesigned, may cause instability of the financial system, which in turn maymagnify macroeconomic instability, In Chile, Argentina and Uruguay, thepreannounced exchange rate policies were reasonably credible at the beginning,but once the monetary consequences of financial-sector instability becameclear, credibility began to evaporate. In Chile's case, it was clear that theGovernment could buttress the financial position of banks by borrowing abroad,but once it reached its limit (in 1981 when Chile began losing its foreignreserves), the Central Bank extended massive financial assistance to thefinancial institutions and contributed to the growth in base money. As aresult, the inflationary expectations, curtailment of which was the mainobjective of the stabilization policy, resurged. It is true that inArgentina, the fiscal deficit was an important factor, but its impact wasmagnified when the Central Bank had to infuse a large amount of credit to bailout the financial institutions.

6.4 Among the Asian countries, the experiences of Indonesia and thePhilippines reflect the two-way effects of the macro environment and financialreforms on each other. Indonesia's macroeconomic imbalances were severe whenreforms were initiated, but they were corrected initially after the reform.However, its troubles were later accentuated when continually high domesticinterest rates led to an increasing loan default rate. In the Philippines,macro- and microeconomic policies combined to accentuate the financial crisis.

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6.5 Second, when capital movement is completely free in an economy wherethe financial market is relatively small, liberalization of domestic interest:rates makes them very sensitive to the pressures of expectations of foreignexchange movement. This often leads to volatile and high domestic interestrates, which may significantly diverge from the long-run equilibrium level.On the other hand, if a government attempts to control domestic interestrates, it may risk massive capital flight. The best approach may be to achievea stable macroeconomic enzvironment which will eliminate any abrupt changes inexpectations about exchange rate movement. When this is not possible, acountry with a small and vulnerable financial market may choose a second-bestapproach of continuing some restrictions on the capital account andmaintaining interest rates. For example, whet; Korea faced major macroeconomicimbalances and political uncertainty in the very early 1980s, if theGovernment had fully liberalized the capital account and domestic interestrates, it might have faced very high domestic interest rates, if not massivecapital flight, and even more serious macroeconomic financial-systeminstability. This suggests that when the domestic economy is unstable or whendomestic financial-sector depth is inadequate, a country may maintain controlover its capital account and domestic interest rates while flexibly adjustingthe latter to the inflation rate and attempting to stabilize the inflationrate. If, on the other hand, a country has already liberalized the capitalaccount and domestic interest rates, it should maintain macroeconomicstability at all cost. It is worth recalling that Japan (until recently) anidseveral other industrialized countries retained capital controls and removedthem only when their financial markets developed maturity and flexibility.

6.6 Third, financial liberalization centered on the banking system seemsto have limitations. These are related to an important feature of bankinginstitutions, i.e., that the banking sector performs both the monetary and thefinancial intermediation function. These two functions do not work in thesame direction, especially when macroeconomic imbalances arise. Often, thegrowth of liabilities and assets of the banking system is constrained by atight monetary policy. When the financial liberalization policy is pursuedconcurrently with a stabilization policy, the intended goal of the policy, toenhance the financial intermediation role of banks, is weakened by themonetary policy directed towards containing inflation. In Korea, theGovernment constrained domestic credit and controlled the growth of M2,although the banks were privatized and allowed greater management autonomy andcompetition. However, owing to the policy of encouraging the competition andinnovations in the NBFIs and securities market, growth of the financial sectorwas achieved through the expansion of the nonbanking financial sector. InPhilippines, the aggressive monetary policy to mop up liquidity by issuinghigh-yield treasury bills and Central Bank bills pushed the interest rates ofthe banking system to very high levels, since the banks had to match theirinterest rates in order to avoid massive disintermediation. The growth of thebanking system was also directly limited by the tight monetary policy of theGovernment. In Malaysia, the liquidity of the banking system, which wasgreatly influenced by the restrictive monetary policy, determined the level ofinterest rates to a large extent, and the resulting high level of these rateswas detrimental to new investment. In Indonesia, a shrinkage of liquiditycredits at the beginning of the reform accentuated the rise in interest rates,which in turn led to the expansion of nonperforming loans via the profitsqueeze on the borrowing corporate sector.

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6.7 The second feature of the banking system stems from the banks' debtintermediation function whereby short-term fixed-fee liabilities (deposits)are transformed into long-term fixed-fee assets (loans). This function placesbanks at the risk of runs and insolvencies in the absence of appropriategovernment supervision and regulation. In addition, the dominance of debtintermediation in the financial markets makes corporate firms (when they arehighly leveraged) vulnerable to economic downturns and increases in interestrates. This has continuously called for some kind of government interventionin bank-oriented financial systems (Cho, 1984). The Korean Government,despite its intention, maintained control over bank interest rates andintervened in credit allocation to prevent massive bankruptcies of corporatefirms in the early 1980s when its economy was shaky and banks were burdenedwith increasing arrears. At the other extreme were the Latin Americancountries and the Philippines, which were involved in the massiverestructuring of banks and corporate firms and experienced sharp credit andmonetary expansion.

6.8 This does not imply that a policy of financial liberalization isunjustified. The point is that a complete liberalization of the bankingsystem when inflation is high and variable has severe limitations. Theresulting high level of real interest rates, when banks are the only financialintermediaries lead to adverse selection in the quality of borrowers and inthe banks' own behavior and these problems assume serious proportion when themonetary authorities attempt to impose a stringent monetary contraction, aswas experienced in several Asian and Latin American countries to restoremacroeconomic imbalances. It is worth remembering that Japan refrained fromfully liberalizing its financial system until financial intermediation byinsurance 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 reformexperiences is that the excessively high positive real interest rates are asdisequilibrating 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 liberalizationbetween the need to maintain a high and positive real interest rate as areward for savers and the imperative to lower the cost of funds to finance newinvestment (D. Khatkhate, 1980 and 1983; W. Coats, Jr. and D. Khatkhate,1985). In the imperfect and oligopolistic money and credit marketscharacteristic of developing countries, a sudden dose of liberalization oftenleads to the overshooting of both nominal and real interest rates, unwarrantedby the "fundamentals" when financial reform, especially interest ratederegulation, is undertaken amid high and fluctuating inflation rates. Theresulting real interest rates often exceed the marginal return to capital, ashappened in the Latin American countries, the Philippines and Indonesia andled to increasing arrearage of the banking system. There is a moral hazardwhen firms borrow to pay interest or simply to stave of bankruptcy rather thanto invest or to finance working capital (A. Velasco, 1988). Domesticinvestment 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 slowingimplementation of reform and maintaining interest rate controls and selectedcredit programs, although the latter were gradually phased out. Indonesia

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backtracked in regard to phasing out liquidity credits under which loans tocertain sectors were subs'Ldized, and Sri Lanka persists with special creditprograms to the present.

6.10 The Asian countrLes were not free from the dilemma arising from highreal interest rates exceeding the margina:L return to capital, but most, except:perhaps the Philippines, softened the impact in different ways. Korea, forinstance, went slowly in implementing reform by maintaining interest ratecontrols and selective credit programs, though the latter were graduallyphased out. Indonesia backtracked in regard to phasing out liquidity creditsunder which loans to certain sectors were subsidized, and Sri Lanka persistswith special credit programs to the present.

6.11 Fifth, in order to gauge how or how much the financial system isdeepened or broadened as a consequence of financial liberalization, one of theindicators often used is the M2 or M3/GDP ratio, However, the indicator mayat times be misleading. To the extent that the ratio reflects the impact ofthe short-term inflow of foreign savings, as happened in the Latin Americancountries, Indonesia and the Philippines, the upward changes in that ratiocannot be taken to represent enhanced efficiency of resources mobilized bysiphoning them away from less productive uses. It may not suggest eitherdeepening or broadening, as the ratio will fluctuate depending upon factorstotally unrelated to the long-term development of the financial system. InLatin America, the so-called dollarization after capital controls were removedspotlighted both the weakness of the financial system and the efficacy of themonetary policy. Furthermore, a mere increase in the deepening, even when itis governed by endogenous factors, does not necessarily mean that well-developed financial markets have been established. As observed in all theAsian countries and in Chile, availability of long-term finance from thebanking system did not show any systematic trend and, in fact, in Indonesia,Chile and the Philippines such funds from the banking system declined. Therewas strong evidence that the high and volatile interest rates drained off thesources of such credit. A shift from short-term to long-term transactions istime-consuming and may call for a supply-leading policy of financial marketdevelopment. Financial deepening, as conventionally interpreted, does not byitself bring "relative prices close to any conceivable range with socialoptima."

6.12 Sixth, financial liberalization assumes that the fully liberalizedfinancial system will function optimally. However, it should be recognizedthat in economies which have a long history of financial repression, theparticipating actors, be they bank managers, borrowers, lenders or publicservants, are not trained in new ways of dealing with a liberal and competi-tive system. For instance, it was suggested by Arellano (1983) that inChile's case some of the blame for a disastrous financial crisis resided "inlittle experience existing in the country in the management of a freerfinancial system' (quoted in D. Hanna, 1987). The concept of "an associativeheuristic" implies that the individual s caution is pronounced in theimmediate aftermath of a disaster and tends to diminish as time passes andmemory of disaster fades. Inability to size up risk and lack of capacity tocope with adverse situations prevented the liberalization program fromsucceeding 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

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helm of the financial institutions (and others associated with them in somecapacity) would have adjusted and become familiar with these new tasks overtime. Training Indonesian public servants and financial managers before fulland comprehensive liberalization might have improved results (D. Cole andR. McLeod).

6.13 Closely related to the above is the need to set up a well-plannedfinancial infrastructure with provision for information flow, legal andaccounting systems and an appropriate regulatory system to monitor itcarefully and continuously. Otherwise, financial liberalization will fail inits main purpose--to orient the financial system towards greater efficiency,competition and effectiveness. In the case of banks, it is not alwayspossible to distinguish a necessary control for monetary stability purposesfrom a supernumerary regulation affecting credit allocation, but it isimperative that essential regulation be strictly enforced because of theoligopolistic nature of the banking system in several developing countries.It is now generally acknowledged that there is widespread concentration ofbanking in developing countries. What is more, in some countries like Chile,the bank holding-company structure is more prominent and adversely affectscompetition, in opposition to the avowed objective of financial liberalizationand deregulation. In the presence of such oligopolistic financial andindustrial structures, freedom in transactions is often harnessed to increasethe market share by price war. For instance, bank holding companies increaseinterest rates on deposits to make inroads in the market for funds, and thisin turn results in higher loan rates. Since loans are provided to theinterlocking firms in which banks have close interest, high interest rates donot affect credit demand. This encourages banks to be even more imprudentbecause they know that the government cannot allow them to go bankrupt withoutjeopardizing the entire monetary system. There is thus a moral hazard whichprovides incentive to banks to lend at very high interest rates in order toreduce liquidity strains. As McKinnon (1986) put it, "the bank is beneficiaryof an unfair bet against the government; it gets to keep extraordinary profitswithout having to pay the full social costs of unusually large losses fromrisky lending." This underscores the need to strengthen the supervisoryapparatus in liberalizing countries so that banks are disciplined inmobilizing deposit and lending operations.

6.14 Seventh, another important lesson is that financial liberalization indeveloping countries should not be considered a replica of liberalization offinancial markets in the highly industrialized countries. What can succeed inhighly industrialized countries may not be suited to the financial systems indeveloping countries. The important differences are: (a) in industrialcountries, the financial system is not a major source of fiscal revenue, as itis in developing countries. This implies that liberalization in developingcountries deprives the governments of resources, and therefore their fiscalpractices are adversely affected; (b) in industrial countries there are othermore important institutional sources of credit such as equity markets with awell-established rule of their own, a good credit-rating system, accountingstandards and wide exposure of financial agents to the array of investmentopportunities. Because of this, there is not the same close link betweenbanks and industrial firms as prevails in developing countries. In view ofthese structural differences, liberalization in developing countries bringsabout greater prudential risk, concentration of owner@hip and moral hazard@

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(Dooley and Mathiesson, 1987). The implication is that a gradual process ofliberalization in developing countries is to be preferred to the suddendismantling of all regulations considered repressive.

6.15 Eighth, the financial reform experience in different types ofeconomies raises a question about how the authorities should proceed inremoving the repressive characteristics of intervention without thedisequilibrating shocks that emanate from the complete, once-for-all type offinancial reforms. A praLgmatic solution may be to evolve a certain set ofmarket oriented indicators based on fuller information from domestic andforeign 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 Japanesestrategies of financial reform. It also should be recognized thatliberalization, even in the developed cotntries, has not brought unmixedblessings. For one thing, after financial liberalization real interest rateshave reached very high levels by historical standards and have afflicted theireconomies and those of the borrowing developing countries. For another,interest rates have been most volatile in recent years. As a result, interestrate risks have been transmitted from financial intermediaries to borrowers toa greater extent than before (V. Galbis, 1987). The implication is that agradual process of liberalization in developing countries is preferable to thesudden dismantling of all regulations recognized to be repressive.

6.16 Finally, financial reform, whether comprehensive and sweeping ormeasured and gradual, does not seem to have made any significant difference tothe saving and investment activities in the liberalized economies. It wasbelieved until recently that removal of the repressive policies would boostsaving. The survey in this paper of the consequences of reforms does notreveal any systematic trend or pattern in regard to saving (and alsoinvestment), though it clearly demonstrates that reform has greatlycontributed to the financialization of savings. In most of these countries,saving changed in a random fashion. There were, of course, shifts in themagnitude of saving and investment as between the public and private sectors.Though this study has not analyzed the factors determining saving, it lendssupport to the by now well-acknowledged conclusion that decisions to save aredetermined by several factors and the relationship between savings and realinterest 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 isdesirable, its modality, design and phasing are no less important. In shallowfinancial markets, full liberalization does not appear to be the first bestpolicy. Until other nonbank capital market develops and functions effectivelyand substantial progress is made in regard to structural adjustments in trade,industry and the legal isystem underlying the financial system as a whole, asecond best policy may be to have a diminishing degree of governmentintervention in the financial markets spread over a period of time, derivingguidance from the market-related indicators. The government intervention ismarket--destroying or market promoting. While the former type of governmentintervention eventuated in financial repression in the past in many adeveloping country, the latter may assist them to reach in course of time afully liberalized, efficient and progressive financial system.

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Select Bibliography

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STATISTICAL APPENDIX

Tables Pag:e

Korea 1-a Macroeconomic Indicators 123

1-b Macroeconomic Indicators 124

2 Debt-equity ratio of manufacturing firms 125

3 Interest rates and CPI growth rates 126

4 Various lending interest rates 127

5 Shares of Korean financial institutions 128

6 Various interest rates 129

7 Changes in minimum reserve Requirements. 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

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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

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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 70of 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 173financial 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)

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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: 190Private National Banks

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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 193deposit 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 206institutions 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 11.92NOMINAL 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 30.2GROSS 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 32.8PUBLIC (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 6.6PRIVATE (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 0.219CHANGE 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 4.011TOTAL 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 BANKSDISCOUNT 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 FOREIGNCURRENCY 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 CURBYEAR RATE BOND MARKET

1973 15.5 33.31974 15.5 - 40.61975 15.5 20.1 41.31976 17.0 20.4 40.51977 18.0 20.1 38.11978 19.0 21.1 41.21979 19.0 26.7 42.41980 20.0 30.1 44.91981 18.0 24.4 35.31982 10.0 17.3 33.11983 10.0 14.2 25.81984 10.8 14.1 24.81985 10.8 14.2 24.01986 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 RESERVEREQUIREMENT RATIOS

EFFECTIVE FROM DEMAND DEPOSITS TIME AND SAVINGSDEPOSITS

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 5.5NOV.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 TOAGRICULTURAL COOPERATIVES, AND THOSE IN [ ]REPRESENTS THE RATIOS APPLICABLE TO FISHERIESCOORPERATIVES.

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 ANDFINANCE COMPANIES 1622 9407 20984 42273 54971 70118 64990

INVESTMENT ANDTRUST COMPANIES 53 2413 6351 27683 36536 43129 49027

MUTURAL SAVINGS &FINANCE COMPANIES 507 1607 4000 9566 14743 19917 23878

LIFE INSURANCECOMPANIES 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 ASSETSSOURCE: FEDERATION OF KOREAN BANKS, THE ANALYSIS OF THE EFFICIENCY OFBANKING 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 5001.8FINANCIAL 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 RATEKOREA

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

QUARTERo LENDING RATE + CPI OROWTH RATE

CHART K2: INTEGRATION OF INTEREST RATESKOREA

50

40 J

30 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~-

20 -

10

1974 1975 1970 1Q77 1978 1979 10 19Q 1082 1983 1084 1 1

YEAR0 GENERAL LOAN RATE + CORPORATE BOND RATE O CURB MARKET RATE

CHART K3: INTEREST RATES SPREADKOREA

30 -

28 -

26

24 -

22

20

18

14J ~ 1

16

14

1974 1975 1976 1977 1978 1079 1Q60 106 198 1Q63 1984 106 196

YEARo BANK LOAN RATE + TIME DEPOSIT RATE

CHART K4: MOVEMENT OF INTEREST RATES30 -

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 SECTORKOREA

90-

80

70 -

60

30~~~~~~~~~~~~~~~~~~~~

50

40-

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

YEAR0 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 1.0SNOKINAL 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 27.81GROSS 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 34.01PUBLIC 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 0.01PRIVATE 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 0.238CHANGE 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 0.378CHANGE 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 -1.062CAPITAL 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 4.562LONG TERM DEBT IN USS MIL - - - 1843 - - - 5196 7318 11336 14557 16094 18056 19650LONG 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. 4ISOURCE: INTERNATIONAL FINANCIAL STATISTICS, IMF, 1987. 4

- 145 -

APPENDIX MALAYSIA TABLE 4-a: ASSETS OF VARIOUS FINANCIAL SECTORS

UNIT: MI1L OF RINGGIT

AS AT END OFSECTOR 1960 1970 1980 1985 1986

BANKING SYSTEM 2356 7455 54346 118293 129470

MONETARY INSTITUTIONS 2346 6882 45180 91342 100237CENTRAL BANK 184 2227 12994 16525 20201

CURRENCY BOARD 930 195 - - -COMMERCIAL BANKS 1232 4460 32186 74817 80036

NON-MONETARY INSTITUTIONS 10 573 9166 26956 29233FINANCE COMPANY 10 531 5635 17833 19635MERCHANT BANKS - - 2229 6296 6374DISCOUNT HOUSES 42 1292 2827 3224CREDIT GUARANTEE CORPORATION - - 10 - -

NON-BANK FINANCIAL INTERMEDIARIES 1197 4167 19807 49977 57656

PROVIDENT, PENSION ANDINSURANCE FUNDS 836 3156 13846 32643 37225

EMPLOYEES PROVIDENT FUND 633 2265 9481 24708 28467OTHER PROVIDENT FUNDS 100 452 1889 2904 3265LIFE INSURANCE FUNDS 83 324 1657 3646 4080GENERAL 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 OFSECTOR 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 ANDINSURANCE 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 1984JUNE

SHARE IN TOTALDEPOSITS 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 TOTOTAL 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 GROWTHIN 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 1113.3GAP(-) SURPLUS(+)

LOANS-DEPOSITSRATIO (%) 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

PERFORMANCEAS RATIO OF TOTAL ASSETS

INTEREST MARGIN 2.19 2.64 2.24 3.09 4.14EARNING MARGIN 3.06 3.06 2.91 4.33 4.95OPERATING COST 1.04 2.03 2.20 2.41 3.10PERSONNEL EXPENSES 0.95 1.39 1.52 1.92 2.28NET INCOME 2.02 1.03 0.71 1.92 1.85GROSS PROFITS 1.37 0.43 0.49 0.70 0.76DEPRECIATION AND PROVISIONFOR BAD DEBT 0.31 0.60 0.22 1.25 1.09

AS RATIO OF EARNING MARGINNET NONINTEREST INCOMES 28.49 13.87 23.16 28.82 16.29OPERATING 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 IITALIAN BANKING SYSTEM: A COMPARATIVE ANALYSIS," ITALIAN CREDIT SSTRUCTURE, 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 11977 37 16 461 33 189 12 11978 37 16 509 33 197 12 11979 38 16 529 36 206 12 11980 38 16 546 37 214 12 11981 38 16 573 39 230 12 21982 38 16 608 40 248 12 31983 38 16 664 41 275 12 41984 38 16 716 43 303 12 41985 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 BANKLENDING, 1970-85

UNIT: MIL OF RINGGIT

1970 1975 1980 1983 1984 1985

TOTAL LOAN ANDADVANCES 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 LOANSLESS 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 OVER4 YEARS 102.2 1255.0 5415.9 11636.4 14387.6 16309.6

TERM LOANS OVER4 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 1.231975 4658.812 3654.213 1.271976 5580.754 4339.968 1.291977 6606.752 4663.629 1.421978 7649.247 5417.729 1.411979 7343.216 5248.889 1.401980 9260.182 6736.968 1.371981 10550.055 8339.861 1.271982 11382.253 9837.185 1.161983 15711.902 12230.917 1.281984 18272.076 15647.725 1.171985 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/CSUSPENSE 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

YEARO 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

YEARiJ BAW4 LENDING + FINAN. LENDING 0) CPI GROWTH RATE

CHART M3: MOVEMENT OF INTEREST RATESMALAYSIA

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 SECTORMALAYSIA

120 -

110

100 /

I-~ 0

80 -

0~~0

760

50

40

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

YEAR0 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 13.41PUBLIC - - - - 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 0.102CHANGE 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 - 3.31XCAPITAL 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 -4.572DOMESTIC 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 4.26XFOREIGN 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 0.82GDP 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 23.9159B.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 11.253B.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 22.2H3/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 -20.7OTHER PUBLIC SECTOR 2.5 2.0 4.1 11.0 14.5 17.8 13.3 11.5PRIVATE 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 GNPGOVERNMENT 3.0 3.2 5 4.1 2.6 2.4 1 9 -3.1OTHER PUBLIC SECTOR 0.9 0.7 1.2 2.9 2.7 3.0 2.2 1.7PRIVATE 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 -5.0OTHER PUBLIC SECTOR 2.5 1.2 2.2 5.3 6.3 5.2 3.3 2.8PRIVATE 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 24.1SOURCE:------_---------___--__--____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 34.201975 9.500 12.000 6.801976 10.000 12.000 9.201977 10.000 12.000 9.901978 10.000 12.000 7.301979 12.000 14.000 17.501980 14.000 14.000 18.201981 16.743 17.119 13.101982 14.674 19.184 10.201983 16.512 20.673 10.001984 32.129 36.405 50.301985 15.520 18.696 23.101986 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 AVERAGEINTERMEDIATION COST, 1983-86

(%)

1983 1984 1985 1986

TAXES20% FINAL TAX 2.00 2.60 2.19 1.465% 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 1.60BANK 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 BANKSMESIJRES OF CONCENTRATION

TOTAL ASSETS1979 1986 1987

CONCENTRATION RATIOSTHREE 'BANKS 41.1 41.1 31.4FIVE BANKS 50.0 52.0 47.0

HERFINDAHL INDEX 0.11 0.10 0.06RECIPROCAL 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 DAYSSOURCE:CENTRAL BANK OF THE PHILIPPINES

- 171 -

APPENDIX PHILIPPINES TABLE 9: TOTAL ASSETS OF THE FINANCIAL SYSTEM1980-86

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 57COMMERCIAL BANKS 138.4 44 248.5 34 80

PRIVATE DOMESTIC BANKS 85.1 27 166.6 23 96GOVERNMENT BANK 34.6 11 34.8 5 1FOREIGN BANKS 18.7 6 47.1 7 152

THRIFT INSTITUTIONS 10.6 3 17.6 2 66RURAL BANKS 5.6 2 9.3 1 66SPECIALIZED 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:TSMARGIN OPERATING INCOME BEFORE TAX AFTER TAX

1970 2.62 2.70 1.49 1.491975 1.90 2.76 1.99 1.471980 1.90 2.02 1.16 1.081981 2.09 2.28 1.10 1.001982 1.88 2.15 0.96 0.911983 1.65 2.65 1.06 0.1981984 1.01 3.11 0.51 0.421985 -0.28 2.48 -1.52 1.621986 0.44 2.50 -0.99 -1.11

*1987 2.65 2.01 1.37 1.11

*FIRST HALFSOURCE: CENTRAL BANK OF THE PHILIPPINES.

APPENDIX PHILIPPINES TABLE ll:LOANS OUTSTANDING OF FINANCIALINSTITUTIONS 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 19861.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 6.852.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 17.064.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 -1.526. - 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,CP1PHIUPPINES

N00-,

do

50

40-

30~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0

20

I0

1074 1975 1976 1977 1976 1979 i1 1Q9& iQW *093 1Xa54 195 19

YEARo 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 1965YEARS

CHART P3: MOVEMENT OF INTEREST RATESPHILIPPINES

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 SECTORPHILIPPINES

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

YEAR0 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 1986I.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! 21.1tPUBLIC 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 14.12GROSS 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 25.52PUBLIC 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 0.137CHANGE IN H2/PRIVATE SAVINGS - - - - - 0.201 0.224 0.271 0.171 0.151 0.498 o.355 0.478 0.278 1CHANGE IN M3/ PRIVATE SAVINGS - - - - - - 0.232 0.285 0.180 0.163 - - - -

- ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~OD00IV.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 5.91GDP 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 1B.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 14.5PRIVATE NATIONAL BANKS - 15.7 16.8 18.2 18.1 18.4 18.8 20.7 17.8 14117PRrVATE 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 15.0PRIVATE NATIONAL BANKS - 17.9 18.1 20.0 19.8 19.4 19.7 20.5 19.8 14/18PRIVATE 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 14/15PRIVATE 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 5.9WHOLESALE 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 15.0PRIVATE NATIONAL BANKS - 17.9 18.1 20.0 19.8 19.4 19.7 20.5 19.8 16.0PRIVATE 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 10.3M21GNP (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 25.6M3/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'ODINDUSTRY 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 ASSETNUMBER (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 FOREIGNEXCHANGE 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 17.6OTHER COMMERCIAL

BANKS 59 59 56 517 720 1096 1666 3600 29.5 38.8DEVELOPMENT BANKS 28 28 28 954 1336 1757 2276 3500 33.1 21.9

SAVINGS BANKS 3 3 3 256 452 683 - 1900 86.5 30.6NONBANK FINANCIAL

INTERMEDIARIES 13 14 14 557 805 1108 1327 2100 42.6 21.3INSURANCE COMPANIES 83 89 100 386 528 708 - 3000 35.0 33.8LEASING COMPANIES 34 38 83 60 114 380 386 1400 44.0 69.5STATE 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 ASSETSGROSS 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 FOREIGNEXCHANGE 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 17.6OTHER COMMERCIAL

BANKS 2.0% 2.3% 2.7% 3.2% 4.0% 29.5 38.8DEVELOPMENT 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 30.6NONBANK FINANCIAL

INTERMEDIARIES 2.2% 2.5% 2.7% 2.6% 2.3% 42.6 21.3INSURANCE COMPANIES 1.5% 1.7% 1.7% - 3.3% 35.0 33.8LEASING COMPANIES 0.2% 0.4% 0.9% 0.7% 1.6% 44.0 69.5STATE 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 ANDRESIDENTS'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 PROFITSSTATE BANKS

(AS % OF TOTAL ASSETS)

ESTIMATED1982 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 INTERESTREVENUES 0.8% 0.5% 0.5% 0.2% 0.2%

FOREIGN EXCHANGE TRANSACTOINSREVENUES 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)

ESTIMATED1982 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 INTERESTREVENUES 0.8% 0.5% 0.5% 0.2% 0.2%

FOREIGN EXCHANGE TRANSACTOINSREVENUES 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)

ESTIMATED1982 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 MARCH1980 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 MARCH1980 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 RATEIN SBI 30 DAYS 16.13 15.18 14.00AUCTIONS

90 DAYS 16.52 15.91 15.00…---------------------------------------_____--------------------__-----

SBPU 1 MONTH - 15.525 14.35SELLING RATESOF FICOR 3 MONTH - 15.33INVEST

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 14.506 MONTHDEPOSIT RATE PNB 20.70 17.80 14/17

FB 21.40 17.00 15.00…----------------------------------------------------------------__-----

SB 18.70 17.80 15.0012 MONTHDEPOSIT 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-1 210

0- I I I

1977 1978 1979 1980 19U1 1982 -193 1984 196 1aw

YEAR0 E(l F BANKS + PRI.NATIONAL BANKS ° PRI.FOREION BANK

CHART 12: MOVEMENT OF INTEREST RATESINDONESLIA

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

YEAR0 STATE BANK 12m.DPST 0 CPI GROWTH RATE

CHART I3: GROWTH OF FINANCIAL SECTORINDONESIA

26

25

24

23

22

21

20

19

18

17

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985

YEAR0 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, 1980-1984ALL COMMERCIAL BANKS

(AS % OF ASSETS)

1980 1981 1982 1983 1984

INTEREST RECEIVED 10.1 11.8 12.5 11.8 11.1INTEREST 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 TAXESAND PROVISIONS 4.3 2.8 2.1 2.4 1.4

*MEMORANDUM ITEM: UNIT: MIL OF RUPEESTOTAL 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, 1980-1984STATE BANKS

(AS % OF ASSETS)

1980 1981 1982 1983 1984

INTEREST RECEIVED 10.2 11.4 12.1 11.4 10.9INTEREST 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 TAXESAND PROVISIONS 3.6 1.8 1.3 1.8 1.2

*MEMORANDUM ITEM: UNIT: MIL, OF RUPEESTOTAL 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 11.4INTEREST 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 TAXESAND PROVISIONS 6.3 5.4 4.0 3.5 1.8

*MEMORANDUM ITEM: UNIT: MIL OF RUPEESTOTAL 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 11.20CENTRAL 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 11.25SAVINGS 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

0NATIONAL 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 12.0012 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 13.0010-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 10-30UNSECURED 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 8-20NATIONAL 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 CREDITBY MATURITY, 1976-1985

(PERCENTAGE DISTRIBUTION)

1976 1980 1981 1982 1983 1984 1985

LESS THAN1 YEAR 73.6 70.2 68.9 68.9 71.0 72.2. 71.4

ONE TO5 YEARS 19.6 21.2 20.9 22.2 20.4 18.6 18.3

OVER5 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 33.1COMMERCIAL BANKS 33.5 34.9 37.1 37.4 38.0 38.3 40.2 40.5 42.1FCBUs, NET OFFOREIGN LIBILITIES - - - 1.3 1.9 2.5 2.3 3.2 3.4NATIONAL SAVINGS BANK 9.1 8.9 9.2 7.8 7.1 8.3 8.7 9.2 9.8FINANCE 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 ANDINVESTMENT BANK - - 0.2 0.3 0.3 0.3 0.5 -

DFCC _- - 0.4 0.5 0.5 0.6 0.6 0.6EMPLOYEES' PENSION FUND 8.6 8.4 8.2 7.4 7.4 7.7 7.9 8.7 10.1EMPLOYEES' TRUST FUND - - - - 0.1 0.3 0.5 0.8 1.0INSURANCE 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 RATESSfa 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

43

2-

1070 1975 1976 1977 1078 1070 1Q60 1061 10&2 1Q6 104 1065 10aw

YETARLI TREASURY BILLS 4f NATIONAL SAVINGS BANK SAVINGS SAVINGS DEPOSIT 0 COMMERCIAL BANK SAVINGS SAVINGS DEPOSIT

CHART S3: GROWTH OF FINANCIAL SECTORSR LMNKA

60-

55-

50

45

40

35

30

25

20 -

1975 1976 1977 1978 '1979 1980 1981 1982 19M 1984 1985 1986

YEAR0 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- REALYEAR 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 88.0PHASE 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 6.1 127.7POST- 1981 -7.0 20.1 104.0 -8.21 -3.73 6.0 114.3REFORM 1982 -3.8 15.3 165.2 -7.18 -4.18 6.4 109.9RECESSION 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 5.9 167.61985 -4.9 11.8 672.2 - -1.46 7.2 124.51986 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-POSTYEAR 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 5.72NOMIRAL 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 14.61PUBLIC 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 7.61PRIVATE -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 18.42PUBLIC - - - - - - 9.01 10.62 5.51 -0.82 -0.12 0.62 3.82 4.42PRIVATE - - - - - - 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 5.6XK2/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 19.82M3/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 0.213CHANGE IN M21PRIVATE SAVING - - - - - - 1.010 0.998 1.158 0.129 -0.088 0.403 0.382 0.279CHARGE 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 -6.492CAPITAL 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 5.281EXTERNAL 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 19.52GDP 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 84.282 101.123 163.552 226.440B.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- REALYEAR 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 43.4PHASE 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 17.1 101.8REFORM 1982 -14.1 14.6 9.9 -0.98 -9.47 19.6 95.3RECESSION 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 13.9 130.01985 2.4 14.2 30.7 -2.36 -8.30 12.0 162.61986 5.7 14.6 19.5 - -6.49 8.8 198.3

…----------------------------------------------------------------_-__--------__----------------

SOURCEBALANCE 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-POSTYEAR 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- REALYEAR 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 8.1 136.21975 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 11.6 107.61976 4.0 15.4 50.7 -2.07 -1.95 12.9 118.71977 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 10.1 100.079-81 4.7 16.2 54.8 -0.49 -5.32 8.4 94.01979 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 92.01981 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 87.8REFORM 1982 -9.4 15.1 19.0 -9.06 -2.54 11.9 97.9RECESSION 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 70.51985 0.0 7.7 72.2 -2.24 -2.11 - 81.51986 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-POSTYEAR 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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RECENT WORLD BANK DISCUSSION PAPERS (continued)

No. 31. Small Farmers in South Asia: Their Characteristics, Productivity, and Efficiency. InderjitSingh

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 Rottenbergand 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. Voluntary Debt-Reduction Operations: Bolivia, Mexico, and Beyond... Ruben Lamdany

No. 44. Adjustment Programs and Social Welfare. Elaine Zuckerman

No. 45. Primary School Teachers' Salaries in Sub-Saharan Africa. Manuel Zymelman and Joseph DeStefano

No. 46. Education and Its Relation to Economic Growth. Poverty, and Income Distribution: Past Evidenceand Further Analysis. Jandhyala B.G. Tilak

No. 47. International Macroeconomic Adjustment, 1987-1992. Robert E. King and Helena Tang

No. 48. Contract Plans and Public Enterprise Performance. John Nellis [Also available in French (48F)]

No. 49. Improving Nutrition in India: Policies and Programs and Their Impact. K. Subbarao

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