Financial liberalisation and crisis: Experience and lessons for Zimbabwe

Abstract

The financial sector development history of Zimbabwe has been dominated by episodes of financial repression. The main instruments of financial repression have included interest rate ceilings, selective credit rationing policies, restrictions on the remittance of capital, exchange controls and taxes on financial assets, zero-interest reserve requirements and a mesh of liquidity ratios. Inflation tax has also been used as a subtle form of financial repression. The rationale for financial repression has been based on the premise that government intervention would remedy the existing structural weakness of the market, channel resources to priorities sectors, which were considered as the engines of growth. Thus, the targeted sectors or companies that received subsidised credit (especially public enterprises) had easy access to scarce foreign currency (through import licences) and/or government guarantees (Chigumira, 2000). The episodes of financial repression have been accompanied by low savings, excessive credit rationing and low investment. This adversely affected the quality and quantity of investment as bankers adopted credit-rationing policies and practices that encouraged inefficient and/or capital intensive projects. Banks are also likely to have invested less in risk assessment and monitoring systems especially where banks were forced to lend to targeted sectors. There has been a burgeoning literature that questioned the wisdom of financial repression and provided financial liberalisation as an alternative framework for managing the financial sector. Within this literature financial repression has been considered as a second best strategy that is adopted when institutional constraints prevented Governments from collecting enough tax revenue to finance expenditure. Asset price distortions caused by financial repression have inhibited the development of the financial sector and undermined the sector’s contribution to economic development. In particular, administered deposit rate ceilings in an environment of high nominal inflation rates resulted in negative real interest rates, which curtailed savings mobilisation. In this regard measures that repress the financial sector consequently reduce the size of the banking system and stifle financial intermediation. The emergence and perpetuation of financial dualism (the co-existence of the formal

and informal financial sectors), has in part been attributed to repressive financial sector policies among other factors. The financial price differentials and market segmentation caused by this dualistic structure caused further distortions in the economy. The main policy recommendation by McKinnon (1973) and Shaw (1973) and more recently from the endogenous financial development literature is to liberalise the financial sector. This entails decontrolling of interest rates, removing other controls that inhibited the development of the money and capital market. It was envisaged that positive real rates of interest would stimulate financial savings and thus expand real supply of credit within the financial sector. The increase in credit would consequently increase the volume of investment in productive sectors of the economy. This would ultimately stimulate growth not only through increased volume of investment but also due to increases in the average productivity of capital (see King and Levine 1993). Increase in productivity will arise because market determined interest rates, based on appropriate risk assessment will eliminate low risk and low-yielding investments in favour of high risk and high return investments. Financial liberalisation featured as a major component of the International Monetary Fund (IMF) and World Bank supported structural adjustment programmes (SAPs) that were adopted and implemented in a number of African countries in the 1980s. Country experiences with financial liberalisation have been varied and wide depending on a number of factors including the initial conditions; market failures and sequencing of the reforms, among others. In some instances, financial liberalisation induced financial sector deepening and in others financial crisis. This paper provides a synopsis of the international and country’s experience with financial liberalization/reform. The ultimate objective is to draw lessons from cross-country experiences on the design and implementation of financial reforms.