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Finance and fiscal policy for development (Public Administration: The…
Finance and fiscal policy for development
01.Role of Financial system in economic development
6 major functions of financial sector
Providing payment services
Matching savers and investors
Generating and distributing information.
Allocating credit efficiently
Pricing, pooling, and trading risks.
Increasing asset liquidity
Differences between Developed and Developing Country Financial Systems
Developed countries
Organized, independent, efficient money and credit market enable government to control money supply and cost of borrowing
Consistent interest rate, regulated by both administration and market forces, allows efficient allocation of savings to most productive uses
Developing countries
Highly unorganized, often externally dependent, and spatially fragmented market and financial institutions
National money supply is hard to regulate (due to openness of economy, pegging system,foreign-currency earnings, currency substitution,etc.
Commercial banking system lacks transparency
Money market divided into 2
Small, organized, legal-binding money market for the elites
Large, unorganized,usurious, even illegal market for the poor
Investment decisions are often not very sensitive to interest-rate movements (ex: inflation-financed industrial growth in South America)
02.Role of Central bank
5 functions of central bank
Issuer of currency and manager of foreign reserve
Banker of the Government
Banker to domestic commercial banks
Regulator of domestic financial institutions
Operator of monetary and fiscal policies
Alternatives to central bank
Currency Boards
- issue domestic currency for foreign exchange at a fixed rate (Argentina 1991-2002)
Transitional central banking institution
- Intermediate step from Currency Board to Central Bank (Maldives, Bhutan, Fiji, etc.)
Supranational Central Bank
- Central bank for a group of small nations in the monetary union. (Africa, Caribbean)
Currency Enclave
- established between formal colonial countries and central bank institution of developing countries. (Panama, Ecuador, East Timor, etc.)
Open economy central banking institution
- when commodities and international capital flows are major component of economic activities (UAE, Singapores,etc.)
Autonomy in Central Bank
Economic Autonomy
- Central Bank does not provide automatic, cheap (below market rate) and unlimited direct credit (money) to Government
Political Autonomy
- Central Bank can operate independently, with board of directors that is independent from government and political influence.
Global Trend toward More Central Bank Autonomy
4 patterns
Shifts from Currency Boards to Central Bank or Currency Unions.
Central Banks now can set price stability or target inflation as one of Monetary policies' objectives.
Divergence among Central Banks regarding financial supervision. Prioritize medium-term price stability.
Participation in currency unions increases Central Bank Autonomy
Development Banking
Specialized public and private financial intermediaries to provide medium- & long-term credit for development projects.
Reason: The lack of appropriate capital from existing commercial banks in developing countries
Raise capital from 1) multilateral loans from national aid agencies or 2) loans from the government.
Often do more than just providing credit
Has been growing substantially
(However) often remove themselves from aiding small enterprises and only focusing on large-scale loans. :
03. Informal Finance and Rise of Microfinance
Informal Finance
Loans and financial services not passed through the formal banking system.
Purpose:
To satisfy financial needs of small-scale business not qualified for traditional banking lending.
Typical example:
Rotating Saving and Credit Associations (ROSCAs) in Mexico, Egypt, China, India, etc.
Microfinance
Basic financial services for people too poor to access normal services or can only with unfavorable terms
Group lending scheme
A group of small borrowers, apply for traditional loan, then allocate funds and repay as a group, thereby reducing borrowing costs.
Factors that is otherwise difficult for small borrowers (without Microfinance)
Poor micro-entrepreneur has little or no collateral
Difficult to determine borrower quality
Small loans are costly to process per dollar lent
3 Current Policy Debates
Subsidies and MFIs
Whether loan subsidies are appropriate?
Pro
: As the poor cannot invest in high-return project, thus cannot afford to pay certain interest. So subsidies are needed for the loan to reach the poor.
Against
: Subsidized credit does not guarantee higher productivities and income
Bundled Poverty Services
Whether to combine microfinance with other program?
Pro
: Doing so will help eliminate non-poor borrowers, improve the poor's health and knowledge
Against
: Bundle Services are more costly; and some lenders do not need those extra programs.
Commercialization
Whether to turn into for-profit institutions
Pro
: To enjoy benefit of a commercial bank (i.e, can accept deposit, become well-regulated, more incentive to expand, etc.)
Against
: become too expensive for the poor, lose potential benefit of NPOs
Potential Limitation of Microfinance as a Development Strategy
Most people prefer a steady job with salary than running a risky micro-business.
Only providing financial credit is not enough for borrower to escape poverty
Whether the impact of microfinance is remarkable
Conclusion
: Microfinance is a powerful tool, but needs to be complemented with other growth, poverty reduction, financial-sector development, human capital, infrastructure building, and conventional job-creation programs.
"Cow banking" in Vietnam
General information of Vietnam
Rank 47th globally in term of GDP; average annual growth rate of 5.2%/ year
Despite massive industrialization, large proportion of population are still in agricultural sector
Great wealth gap among industrial and agricultural sector, among central and border provinces.
Cow-banking Project
Established in 2013 by the Red Cross Organization of Vietnam
Focus on economic development of low-income households in 61 poor and border provinces by providing basic production tools.
Mechanism:
Rent a female, fertilized cow (worth of $200) with zero interest to each low-income family within 3-5 years for agricultural cultivation , along with training programs
Costs for foods, shelter, etc. during the lending period are shared by both the banks and household
If new calves are born during this time, they either belong to the household as future production tools or be contributed back to the system
Results and Limitations
Until 2015: 19,772 cows (worth $9million) have been distributed households in 61 poor and border province
Expected Goal
Time: 4/2013 -12/2014
Provided Cow Numbers: 10,000 for the poor household, veterans, disables, etc. in 34 poor and border provinces
05. Fiscal Policy for Development
Macro-stability and Resource Mobilization
In order to develop in the long-run, government must rely on the efficient tax collection.
For developing countries that lack a well-organized market, fiscal measure is the primary way to stabilize the economy and mobilize domestic resource.
Taxation
Developing countries have much lower Tax Revenue (as % of GDP) compared with developed countries (Table 15.2)
In Developing countries, Indirect taxes constitute the primary source of fiscal revenue
In some countries, tax system can be regressive (The poor pay higher proportion of income tax than the rich) (Mexico)
Factors affecting taxation potential of a country
Per capital real income
Inequality in income distribution
Industrial structure of the economy, the importance of various types of economic activities
Social, political power of various groups
Competence, integrity and honesty of tax-administration
Principal sources of tax revenues
Personal income and property taxes
Corporate Income Taxes
Indirect taxes on Commodities
04. Formal Financial Systems and Reforms
Financial Liberalization, Real Interest Rates, Savings and Investment
Inadequate management, acute economic situations, and restrictive policies weaken the financial industries in developing countries.
artificially low interest-rate ceilings (set by government selling low-interest bond to finance budget deficits)
Credit Rationing and Financial Repression
Banks have to allocate the limited saving fund to finance only large-scale borrowers while ignoring small-scale borrowers.
Solution
: liberalize the financial sector - letting nominal rate to rise to the market equilibrium
Financial Policies and the role of the State
Developing-country-related 7 market failures
(That can be improved with Government Intervention)
"public good" nature of monitoring financial institutions
The Monitoring of financial market benefits everyone,but is undersupplied
Externalities of monitoring, selection, and lending
Market provides too little financial information, and resources are under- or over-allocated.
Externalities of financial disruption
Without government insurance, the failure of 1 major financial institution can have the chain-effect in the whole financial system.
Imperfect Competition
Banking in developing countries are extremely limited. Thus only a small number of loanable funds available to borrowers.
Missing and incomplete markets
Lacking of market for insurance against financial and physical risks.
Inefficiency of competitive markets in the financial sector
Uninsured risks exist and information not freely available, causing market not allocating capital efficiently
Uninformed investor
Investor in developing countries lack both information and means to acquire it in order to make raitional investment decisions
Debate on the Role of Stock Markets
Stock market development greatly encourages overall economic growth.
Stock market promote the availability of liquidity and risk-diversification service, as well as motivate both entrepreneur and established firms.
In order for stock market to develop, macro-stability and policy credibility are important
However:
Stock market may lead to substantial foreign-investor influence over domestic companies.
People may focus on Short-term speculation instead of long-term development.
Disruptive flow of "hot money" into/out of the country may destabilise the economy
State-owned enterprises and Privatization
In developing countries, State-owned enterprises are dominant in utilities, transportation, communication, and several industry
State-own enterprises are the primary provider of public goods, or in industries that require massive capital, strategic industries, and industries where private incentives do not exist.
State-owned enterprises are often criticised for being inefficient
Unlike private firm, SOEs must consider both commercial and social benefit.
SOEs usually have overcentralization of decision-making, which allows little flexibility
Bureaucratizaition
Privatization
Selling public assets to private business interests
Based on notion that: Private ownership bring greater efficiency and growth
However, privatized assets may concentrated in small elite groups that put personal gains above public benefits.
Several debate regarding who can participate in the privatization process, which to privatize, and how to privatize efficiently
Public Administration: The Scarcest Resource
Shortage of public administrative capability maybe the single scarcest public resource in the developing world.
This scarcity also arises from political instability
Questionable rule of law, public disorder, lack of consensus, and major conflicts usually lead to inefficient public administration
Bureaucracy is overstaffed yet lack competent officer
Improving public administration should not be underestimated and