Bel arus country economic memorandum
•• Curtail GDL programs. In the short term, significantly reduce the share of GDL programs and move existing loans granted under GDL to the new Development Bank. Any new GDL should be done through this bank and registered above the line in fiscal accounts. Any other directed or recommended lending though the state-owned commercial banks should be discontinued. Commercial banks should have full autonomy to decide on their lending portfolio and credit terms. Lifting restrictions on credit allocation would immediately release capital to flow to other more productive parts of the economy, but these reforms entail difficult decisions. If the borrower of these lending programs will have to compete to attract financing, the liquidity constraints of some borrowers may tighten and interest rates would likely increase with an unavoidable impact on the real sector. •• Reduce government ownership, foster competition, and enhance corporate governance in the banking system. In addition to curtailing direct state interventions in credit allocation, reforms to stimulate competition among banks will be needed to increase market-based lending. Competition is largely relaxed because of the dominance of state-owned banks. State-owned banks are not subject to market signals and discipline, but, instead, they are under more immediate pressure to respond to government objectives rather than improving productivity. The government has to separate policymaking, regulatory, and direct ownership functions, attach specific objectives to them, and only then it could move toward arms-length performance of the state-owned banks, provided that the latter are tasked with pursuing purely profit objectives and not be burdened with any social ones. Divestiture from direct majority ownership could therefore be pursued over the medium term. Easing entry for the foreign ownership of banks could be an effective means to bring skilled private operators to the sector. Those banks that would remain under state ownership should be required to meet international standards of corporate governance, including clear lines of accountability, a greater focus on performance throughout management, and an independent board. This would not only contain sovereign risk associated with the banking system, but also improve risk management practices and the operational efficiency of the banking system, thereby lowering the cost of financing for borrowers. •• Actively expand the channels for nonbank funding in the economy. The development and deepening of capital markets can play an important role in opening up low-cost and long-term financing options, especially for large corporate entities. This would entail strengthening regulatory frameworks and market infrastructure for cooperate bond and stock markets. In addition, the role of non-depository financial institutions (such as microfinance and housing finance) could be expanded. These reforms of the financial system are integral part of the broader structural reform and liberalization agenda proposed in other chapters of this report. Unless a true market liberalization and a switch to private-sector led growth is achieved, and the government starts pursuing social objectives through policies which do not rely on credit allocations and management of a large enterprise sector, these financial system reforms will not deliver the intended increase in the efficiency of capital allocation. Also, hard budget constraints for most of the SOEs, including removal of explicit and implicit government guarantees, have to come first, in order to incentivize the banking sector to start assessing risks differently and fund most efficient investments rather than most-guaranteed investments.
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Chapter 2. Boosting Efficiencies in Factor Markets