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Saturday, 11 July 2009

Having Your Aid and Keeping It Too (Guest Blog)

There has been much debate lately as to whether or which forms of aid from developed countries to Zambia are truly effective at delivering development. Where the various sides do not disagree apparently is on the need to increase investments in development-related infrastructure by some means, and so that is where I have concentrated my attention. The problem of having aid money coming into the system is that it displaces private capital and is subject to political ideology in its application, leading to waste, inefficiency, and/or corruption. The trouble with not having the aid coming into the system is that its absence will create a shortfall in government revenues such that the existing tax base is insufficient to sustain provision of both social services and infrastructure investments. For as long as the aid continues to come in however, there remains no solid incentive to invest heavily in developing the domestic tax base, and a reliance on the policy of foreign governments to maintain ongoing programmes. I believe that there may be a way out of this trap, one which I hope would be satisfactory to most factions in the aid debate.

The bulk of the money being provided for development purposes is in the form of concessionary loans rather than grants, thus a focus on the portion of capital being contributed which the donors eventually want paid back. The ostensible hope is that after a few decades, they will get their money and Zambia will have reaped the benefits of profitably investing and reinvesting the profits from development projects. Where it all goes wrong is when too much of the original stake gets wasted or stolen, such that the remainder cannot possibly fund enough projects which will grow quickly enough to cover the cost of repayment on schedule however well managed, requiring yet further aid with which to overcome the increased budget deficit. The apparent alternative at that point seems understandably unattractive, being to otherwise raise taxes on the existing domestic economy, further discouraging investment. It is generally agreed that if it were possible, government borrowing that was deemed necessary be done via domestic banks, so as to avoid exchange rate pressures for example, however there simply is not enough money in the Zambian banks to provide the large amounts of credit needed.

I propose that all of these difficulties can be relieved, at least to some degree, by the diversion of some or all of the capital being loaned to the GRZ by other governments into long term deposits in Zambian banks. There it can remain, subject to the same planned eventual withdrawal by the donor after 20 or 30 years, earning enough interest to counteract inflation (they can donate any excess to social services if the interest profits trouble their consciences this time). The increased deposit base will enable those banks to issue credit for all purposes at a rate of 11:1 to domestic borrowers, including the GRZ. Thus each $100 million in deposits by foreign governments can result in an additional $1 billion worth of responsible private sector investments, in addition to the original $100 million required by the GRZ for its own projects (conceivably even still at concessionary terms, though that would affect rates for other borrowers at a 10:1 ratio). Instead of acting as mere brokers between large foreign investors and offshore banks, Zambian banks would be in a position to extend a significant portion of the financing required by the mining, tourism and agricultural sectors being targeted for growth by the GRZ. This would effectively keep a larger portion of the profits from such operations in the country, and thus available for taxation, reinvestment and services. As these new investments mature and begin to show profits, the increased revenues to the GRZ will decrease the need for borrowing and offset potentially higher (non-concessionary) domestic borrowing costs.

I thank you for your time and welcome discussion.

Yakima / USA
(Guest Blogger)


  1. Yakima,

    This is an interesting concept – long term deposits into Zambian banks. I prefer this to Dambisa Moyo’s bond solution. For on face value it looks less risky. That banks can then loan out this money at (fixed) interest rate – is a solution for creating a pool of loan able funds.

    The fact that lenders (donors) to GRZ can withdraw these funds 20/30 years later provides a sense of security - because you know that the money will be there. One reason people use savings account is because of the assurance that they can have access to their funds. Also donors knowing that the money is not in the hands of GRZ bureaucrats, who can waste or steal it, provides another advantage.

    That said: - would the 11% i-rate suggestion stay fixed for a period of time? And who determines this interest rate – Banks, markets, would it be locally or globally calibrated? The Banks where this money is deposited, do they have the flexibility to lend it out also on open capital markets at a different rate? And would the sectors the money is to be lent to be on a qualified list? These are detectable questions.

    Finally, would this arrangement apply to only funds coming from foreign governments and not from private sources or multilateral institutions like IMF & World Bank? If you develop this concept further, you many find a few more supporters. Go for it!

  2. Yakima,

    A very interesting contribution.

    As a general point, I support mechanism that try and handle the accountability problems that we have seen in existing processes and also help the common man genuinely.

    In my review of Dead Aid - Dead Aid, By Dambisa Moyo ( A Review) - I point out that one of the approaches that could be considered for example is investing new aid money, say for civil service pensions, as bond claims by Zambians on the government. That way we provide sufficient incentives for Zambians to care enough about how aid is managed and at the same time put money directly in "their pockets".

    As I was thinking about your idea, I kept thinking whether this has been considered. The closest I remember was the Gemloc idea which supports the development of local currency bond markets, by helping reduce the devaluation risk and thereaby encourage more external flows. But nothing on your line or the idea that I proposed in the review.

    I wonder whether part of the problem is the emerging IMF opinion that developing nations are best served by smaller banks ? See Walk, don't run

  3. Kaela,

    Thank you for your words of encouragement and for those excellent questions!

    If I recall correctly, the 11:1 leverage ratio for lending institutions in Zambia is around the maximum dictated by local law. It is conceivable that individual banks, either out of caution or lack of demand, would issue fewer loans backed by their cash deposits, however this would result in lower revenues and require either higher interest charged to borrowers or reduced default rates to achieve similar profit margins. All things being equal therefore, banks are likely to lend at or near the maximum allowable leverage ratio.

    As to the conditionality placed on recipients of such loans, either by banks themselves, by the GRZ, or by donor governments, I assume that such is likely to be a matter for negotiation between them in some combination. If I had to guess however, I would imagine that donor governments at least would want assurances that loans generated from their deposits were issued to businesses and individuals within Zambia, and may also wish to have a say in mandating interest rates charged to and qualification of borrowers. That said, there is a certain degree of fungibility in banking, so while the foreign deposit is used to back domestic loans, it is entirely possible that money from domestic deposits are used on the broader international capital markets as a hedge against fluctuations in the local economy. Also presumably whatever profits are generated for the banks and local businesses over time would then be beyond the influence of donor government policy, and available for savings or reinvestment in a variety of ways. The short answer is that I wouldn't presume to "pre-negotitate" for the key stakeholders, but I am confident that their interests are sufficiently in common as to make agreement relatively simple.

    Finally, as for private sector or multi-lateral institutional lenders to the GRZ engaging in similar behaviour, I certainly see no obvious barriers, nor significant differences in effects for the Zambian economy. However, the private sector is unlikely to be engaged in concessionary lending, and thus unlikely to see exchange of higher loan interest for lower bank deposit interest as desirable. Also, multilateral institutions are almost universally more difficult to negotiate with than individual donor governments, due to the proliferation of stakeholders and the inclusion of competing interests in the process.

    Likely to be among the toughest points in negotiation is the issue of "early withdrawal" options and conditions (escaping the aid trap is not instant!), whereby depositors who are concerned about the safety of their money or the uses to which it is being put (or simply are so broke themselves at some point in the future that they just need it back), can withdraw in an orderly fashion without unduly disrupting the domestic economy. One such strategy would be to categorize the amount as ten-year certificates of deposit, with one tenth of the deposited amount being "renewable" in any given year. Again, I would not presume to dictate the negotiating positions of any key stakeholder, but I speculate that something similar would be generally acceptable as a safeguard.

  4. Cho,

    I think that Justin Lin is making some good points in that article, however I think that I had a slightly different reading perhaps, as I see the emphasis to be on "local" rather than "small". The local banks are small in the Zambian context, the available large banks are all foreign. When he talks about solutions going forward, he references the consolidation of the local banking sector over time as insolvent facilities are absorbed through liquidation and merger, as well as the creation of new, well capitalized banks to handle increases in demand and presumably also increasingly specialized services.

    I also found somewhat ironic his references that large banks are only required, "when large capital-intensive firms dominate the economy," which seems to describe the Zambian mining sector quite adequately, and by virtue of the sector's relative size and historical position, by extension the whole economy. So, Zambia has an economy dominated by large firms with large borrowing needs, but has no banks large enough to service the demand. If the proposed international deposits were in place in the domestic banking system however, those mine finances could be profiting Zambian bankers, shareholders, and depositors (who are all presumably also taxpayers), and/or potentially paying for the extension of concessionary loan terms for public infrastructure programmes undertaken by the GRZ.

    The evidence indicates to me that existing domestic banks have to grow to catch up to the size of the economy, before we need worry about whether they can also grow along with it or might outgrow it. The smallness hurdle does not seem overly hard to clear, while still enabling a deposit base sufficiently large to domesticate Zambian government and enterprise debts. To whatever extent such a shift in the manner in which external capital enters the Zambian system is implemented, I think it will have lasting positive consequences on growth and development.

    Bonds are certainly something that should not be discarded as a result of this proposal, but their use would hopefully become more flexible and less costly with a reduced urgency for capital overall. The key question in this case is whether or not we can discover a means by which the nation can make use of the capital being offered by foreign governments without becoming dependent on such gifts and/or broken by the repayment terms. This way it is not so much a gift, and more of an investment in the normal sense, such that repayment ought to be a much simpler and transparent activity little different from ordinary personal banking transactions.

  5. Cho and Kaela,

    I should also point out that again there is no magic wand in this equation, so in order to achieve full leverage on the deposits, banks will have to enter into re-lending arrangements with existing large banks (presumably overseas, but conceivably via the Zambian treasury, at least in part). Otherwise there would be no additional cash to pass on to borrowers in the first place. But, much more credit becomes available to the system via the collateral placed in Zambian banks, which enables economy of scale improvements in repayment efficiency, and thus eventual profitability. Oh, and it also funds development in both public and private sectors.

    All of which is contingent on responsible decision making and execution by investors, resulting in reasonable rates of loan default. Loan conditionality should be carefully monitored to avoid irresponsible lending "bubbles," but provided the borrowers are genuinely viable businesses, the increase in available credit should simply be a boon for all concerned.

  6. Not on topic, but might be of interest:

    From The Standup Economist:

    Mankiw's Ten Principles Of Economics Translated


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