DOM{STIC FINANCE STUDIES NO.69

FINANCE AN]) DEVELOPMENT

A POLICY FRA-MEWORK FOR TANZANIA

By,

V.V. Bhatt and Gobind Nankani

The views presented in this paper are solely those of theauthors and do not necessarily reflect the off ici.al oDinions of theWorld Bank or its affiliates.

June 1979

POublic and Private Finance DivisionDevelopment Economics DepartmentDevelopment Policy Staff

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CONTENTS

Page

Preface

Abbreviations

Introduction ............................................ 1

I. Financial System: Evolving Structureand Functions ......................... 4

II, Current Policy Problems .................................. 6

III. Discussion of Some Issues of Current Concern ............. 11

IV. Institutional Structure: Integration andCoordination ..................... 22

V. Financial System and Domestic ResourceMobilization: An Assessment and SomePolicy Recommendations ................................ 29

VI. Allocation of Domestic Resources: An Assessmentand Some Policy Recommendations ........................ 53

VII. Identification of Project Ideas, Project Makingand Evaluation ........................................ 59

VIII. Efficiency of the Financial System ........................ 62

Footnotes ............................................... 70

Appendix: Domestic Resource Mobilization andAllocation: Projections for theFinancial System, 1979-83

STATISTICAL TABLES

Page

1. Transaction Costs .................... ........ .. 16-A

2. Trends in Capital Format^Lon: Selected Ratios 1966-77 ....... 35

3. Financing of Capital Formation by Domestic andForeign Savings ............................................ 36

4. Financing of Capital Formation by Domestic andForeign Savings (as a percentage of GDP atmarket prices) ............................................ 37

5. Components of Gross Domestic Savings 1973-78 ................. 38

6, Private Sector Financial Savings ............................. 39

7. Lending by Financial Institutions to thePrivate Sector ............................................ 40

8. Domestic Savings for Tanzania: Stylized Ratios .............. 41

Table A-1 Money Supply Projections., 1979-83 Appendix 5

Table A-ll Domestic Resource Mobilization and AllocationThrough the Financial System: Projectionsfor 1979-83 ....................... .............. . 6

Footnotes to Table A-ll .................................... 7

ABBREVIATIONS

1. BOT Central Bank of Tanzania

2. NBC National Bank of Commerce

3. TIB Tanzania Investment Bank

4. TRDB Tanzania Rural Development Bank

5. THB Tanzania Housing Bank

6. TDFL Tanzania Development Finance Co. Ltd.

7. TISCO Tanzania Industrial Studies and Consulting Organisation

8. SIDO Small Industry Development Organisation

9. POSB Post Office Savings Bank

10. NIC National Insurance Corporation

11. NPF National.Provident Fund

12. NDC National Development Corporation

13. K.Co : Karadha Company Ltd.

14. NBC National Corporative Bank

15. NDCA National Development Credit Agency

16. PPS Parastatal Pension Scheme

17. IFM Institute of Financial Management

PREFACE

The Governor of the Bank of Tanzania requested me, in early 1978,to urndertake a policy-oriented financial sector study for Tanzania and toexplore the following areas "to provide guidelines for future action".

(i) "Scope and Innovations in the methods ofresource mobilization in Tanzania."

(ii) "Techniques for effective channeling ofdomestic financial resources through thefinancial institutions into the highlyunderdeveloped sectors with a good pro-duction potential."

(iii) "Development of techniques of short and mediumterm credit planning."

Accordingly, with the approval of the World Bank, Mr. G. Nankaniand I went on a mission to Tanzania in December 1978. We spent about threeweeks in Dar-es-Salaam and a week in Arusha; at both places we had stimula-ting and fruitful discussions on various aspects of the financial structureand on financial policies, with the officials of various financial institu-:tions, TISCO, SIDO and the Ministries of Finance and Planning, Industry,Transportation and Communications.

Towards the end of the mission, we prepared a brief outline of ourreport which was discussed with the Governor and approved by him. ThisFinal Report is based on the approved outline. It also discusses in SectionIII certain policy issues that were suggested by the economic advisors tothe Bank of Tanzania.

We have tried to understand the Tanzanian setting and the socio-economic change that has taken place in the last two decades. However,we can hardly have the same feel of the evolving situation as the policy-makers in Tanzania have. Hence, we would like to suggest that even thoughour general approach and perspective appears to be acceptable to them, noneof our specific recommendations be accepted for policy action without athorough and critical discussion among the officials of the financial in-stitutions and the Ministry of Finance and Planning.

V.V. Bhatt

Finance and Development: A Policy Framework for Tanzania

Tanzania is one of the few countries which have identified the

problem of development and socio-economic change as a human problem -

a problem of ensuring to each family initially a minimum level of living

and later a progressively rising minimum. It is for this basic purpose

that it is trying to establish a self-reliant socialist socio-economic

structure. However it is'not possible to generate this cumulative self-

reinforcing process of change without improving progressively the pro-

ductivity of each individual and family - that is without full employment

with rising levels of labour productivity. The critical factors for this

purpose are Organisation, hard disciplined intelligent Work and Thrift and

Competence to benefit from accumulated and growing Scientific and Tech-

nological knowledge. In concrete terms, all these factors hlave to be

harmoniously blended into actual productive projects related to Infra-

structure, Agriculture and Industry.

The financial system's principal and vital role is to facilitate

this process of project making, implementation, operation and monitoring.

This role is even more critical in a country like Tanzania with the

objective of establishing a self-reliant socialist structure of society.

In this context, Tanzania has already set up some of the essential

institutions; it has in a short time already identified the principal

functions of the system,-which has been evolving since 1966.

The principal task now seems to be that of forging vital links

among these institutions with a view to establishing an integrated, well-

coordinated financial system with an in built innovative capacity to

respond to challenges and problems as they arise in the process of socio-

economic change. Our suggestions/recommendations, therefore. center

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around this principal theme of institutionalising the process of inte-

gration and coordination for performing effectively and efficiently the

following vital functions:

(i) To inculcate the habit of thrift and devise appropriate

mechanisms for raising the rate of saving generally,

and in the form of financial assets in particular;

(ii) To institutionalize the process of allocation of

financial resources in the light of development objec-

tives;

(iii) To evolve rational criteria for the choice of individual

projects to avoid waste and inefficiency;

(iv) To supervise and monitor the project implementation

process to ensure utmost economy in the use of resources;

(v) To ensure progressive improvement in the productivity and

performance of enterprises;

(vi) To forge organic functional links between Project

Identification Centers and Managerial and Technical

Consultancy Services centers (like TISCO and SIDO) on

the one hand and the financial system (FS) and the proje.c

promoters on the other, so as to ensure sound formulation

of and linkages among projects centered around the basic

strategy of developing a modern sector that supplements

and reinforces the growth of the traditional sector

(agriculture and rural);

(viii) To establish such institutional mechanisms that can

improve the information base for and reduce the costs

of reaching appropriate rational decisions for the

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financial system as well as project promoters -

particularly the small and medium enterprises in the

farm and the non-farm sectors.

There can be no general and universal prescriptions for all these

functions in a world of uncertainty and imperfect knowledge. The nature of

problems and ot.." understanding of them change with time. What is essential,

therefore, is to institutionalize a process of learning from mistakes - which

is in fact another name for a process of development. Our recommendations

and suggestions, therefore, have to be viewed as merely indicating the

direction of change, and suggesting an institutional and policy framework

that minimises the impact of individual idiosyncracies and prejudices, and

that sets up a rational decision making process making maximum use of

information, knowledge and learning related to the emerging situation and

.problems.

The plan of our paper is as follows. Section I presents a synoptic

account of the evolving instituticaal structure. Some of the important

problems are indicated in Section II, while Section III discusses some

policy issues of current concern.

The rest of the paper - Sections IV to VIII - present our suggestions/

recommendations along with thieir rationale. Section IV emphasises relevant

mechanisms for integration and coordination of the financial system. The

resource mobilisation aspects are discussed in Section V, and the allocation

aspects and, in particular, our suggestions for institutionalising the alloca-

tion process in Section VI. The links between SIDO and TISCO on the one hand

and the Fiscal System (FS) on the other are indicated in Section VII. Section

VIII discusses the rationale for financial innovations that reduce the real

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costs of lending or borrowing.

The final Section presents our projections relating to the resources

of the financial system and their possible allocation.

I

Financial System: Evolving Structure and Functions

1. Since Independence in 1960 and more particularly after 1966, the

structure and functions of the Tanzanian financial system have been changing

as a result of deliberate policy measures. The East African Currency Board

was replaced by the Bank of Tanzania (BOT) in 1966. The BOT was visualized

in the 1965 Act as a central bank with the conventional regulatory functions

vis-a-vis seven commercial banks, of which only one - Tanzania Bank of Com-

merce Ltd. - was an indigenous bank; however, this more or less competitive

structure of commercial banking was radically altered in 1967, when all

these banks were nationalised and merged into a single commercial bank -

the National Bank of Commerce (NBC), expected to function as a mixed - or

universal - bank, providing both sbkrt-term and medium to long-term credit

to the non-agricultural sectors of the economy. The NBC set up in 1968

Karadha Company Ltd. (K.Co.) for providing hire-purchase finance. For

agricultural finance, there were two institutions - the National Coonerative

Bank (NCB) and the National Development Credit Agency (NDCA) - the lormer

providing short-term credit and the latter medium to long term credit to

agriculture, through the cooperative unions.

2. Along with the nationalisation of the commercial banks, the in-

surance companies were nationalised in 1967 and a single corporation was set

up - the National Insurance Corporation (NIC) - to handle both general and

life insurance business.

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3. This sector-wise differentiation of credit functions was altered

when the Tanzania Investment Bank (TIB) and the Tanzania Rural Development

Bank (TRDB) were set up in 1970 and 1971 respectively. The medium/long-

term credit function of the NBC was taken over by the TIB, while the TRDB

replaced the NDCA. The NCB was merged with the NBC, which was now to prol-

vide short-term credit needs of all the sectors of the economy. In 1972,

a special bank was established - the Tanzania Housing Bank (THB) - for

providing credit to the housing sector.

4. After 1971, the TRDB was expected to meet the developmental credit

needs of agriculture and rural enterprises and the NBC was to provide short-

term credit. However, the NBC could meet the short-term credit needs only

of relatively large estates, ranches and such other large borrowers. Hence

the TRDB had to assume the function of provision of short-term credit to

the farmers through Cooperative Unions and the related primary cooperative

societies. As a result, the development credit needs of agriculture were

virtually neglected. In 1976, the cooperative credit system was dissolved

partly due to its inefficient functioning but mainly due to the government

decision to make Ujamaa Villages as registered corporate bodies - the main

instrument for promoting integrated rural development and bringing about

the transformation of the rural society in terms of the declared goals of

socialism and self-reliance. The TRDB thus has now to evolve the mechanisms

for providing credit to the Ujamaa Villages; currently, it is not well equipped

to provide credit either directly to the farmers or indirectly through the1/

Village set-up. These mechanisms are still being evolved.

D. Thus by 1977 the firnancial structure was radically altered. Obviously,

the conventional central banking functions had become obsolete with only one

commercial bank. The specialised institutions - like the TRDB, TIB and THB -

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had no links with the central bank. Accordingly in 1978 the Central Bank

Act was changed in recognition of the new situation. The BOT is now brought

into direct financial relationship with the special financial institutions,

which are empowered to borrow for their short-term needs from the BOT. The

BOT is given powe,s to create long-term funds out of its profits for pro-

viding long-term resources to the special institutions; initially a Rural

Finance Fund has already been set up. The BOT has now powers of super-

vision and inspection over the special institutions and also the function

of determining the volume and allocation of credit and an appropriate

structure of interest rates in the economy, and evolving institutions for

providing training facilities f6r the staff of the financial system. The

BOT finally has been entrusted with the function of participating with the

government in the preparation of the Annual Finance and Credit Plan, and

monitoring its implementation with a view to suggesting such policy measures

as may become necessary in the light of the emerging situation. In the

words of the Finance Minister, the BOT as a central bank has been given a

developmental function !'so that the bank can play a more active role in

fostering rural development and monitoring the financial and monetary policy

of the government in coordination with other institutions". (Budget speech,

1978). The BOT, thus, has assumed the role of a leader and a coordinator

of the financial system; however, it has still to evolve an appropriate2/

mechanism and policy instruments for the purpose.

II3/

Current Policy Problems

6. The major problem that faces the financial system is: how to increase

the resources mobilised by the system and to devise rational criteria and

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mechanisms for their allocation initially among the various financial

institutions and through them to the various sectors of the economy.

A: Resources Problem of TIB, TDFL, TRDB and THB

7. The resource mobilisation function is primarily performed through

two broad financial instruments: deposits and claims on social security

institutions. Currently, the NBC, THB and the Post Office Savings Bank

(POSB) provide deposit type instruments, while the NIC and the National

Provident Fund (along with the recently created Parastatal Pension Scheme)

provide the social security type of instruments. Thus, NBC, THB, NIC and

the NPF mobilise financial resources. The industrial development banks -

TIB and the private development bank, The Tanzania Development Finance

Company Ltd. (TDFL)- and the TRDB do not mobilise resources directly and

depend on the government and other domestic and international agencies for

their resources. Of course, even the THB has to depend for about 50 per-

cent of its resource requirement on the government and the other domestic

and international agencies. The institutions with surplus resources are

only the NBC, POSB, NIC and the NPF. These four institutions provide

resources to the government which, in turn, transfers a part of them to

the TIB, TRDB and the THB. Since these three institutions have to depend

on annual budgetary allocation of resources, it is obvious that they can-

not effectively plan their activities over a longer period. The question

is: whether a certain proportion of the resources of the NBC, NIC and

the NPF cannot be reserved for allocation to the term-lending institutions

through the former's acquisition of their bonds. The marginal changes in

their aLlocation pattern will, of course, have to be made in the light of

the Annual Finance and Credit Plan, for which the TOB has the primary

monitoring responsibility.

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B: Problem of Evolving AppropriateMechanisms for Rural Credit

8. After the dissolution of the corporative credit structure, the TRDB,

as was mentioned earlier, has to evolve with the assistance of the BOT direct

links with the Ujamaa Villages for the provision of all types of credit to

the rural sector. The problem currently is to evolve a viable structure at

the Village and District level; the TRDB offices are only at a Regional level

(21 offices in all).

C: Small Enterprise Financing Problem

9. Tanzania has a deliberate policy of promoting small enterprises in

rural as well as in urban areas. The Small Industries Development Corpora-

tion (SIDO). has been set up since 1973 and has so far done considerable work

relating to the identification of project ideas, feasibility studies, mana-

gerial and technical guidance and training facilities. It has one office

(Small Industries Promotion Office - SIPO) in each region, six industrial

estates, seven industrial workshops, four training centres and four training-

cum-production centres. Its major aim is to foster the establishment of such

small enterprises that can produce goods for local consumption on the basis

of local materials and skills, that are either traditional and can be upgraded

or can be easily acquired at its training centres. In Arusha region alone,

it has been instrumental in revitalising small enterprises in 80 different

fields and promoting enterprises in 80 additional new fields. These projects

relate to bamboo craft, blacksmithy, sheet metal work, wood-work, handloom

weaving, village oil extraction, hand-made paper, cement, open-pan sugar

promotion, jaggery, clay tiles and bricks, furniture, ceramics, fruit preserva-

tion, making of jigs and fixtures and repair shops.

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10. The SIDO is providing materials and machines to these small enter-

prises through its bulk purchases and also provide marketing assistance.

The machines are provided on a hire-purchase basis, and working capital

credit needs to some extent are met by the NBC.

11. The problem is: whether a development agency like the SIDO should

be burdened also with a financing functlon and whether the small enterprises

should have to depend on two different agencies for their credit needs.

Again, the urban small-medium enterprises (of the ancillary type) face a

credit problem; the TIB does not make a loan of less than TSh. 100,000,

while the NBC does not provide medium-long term finance. The question is:

whether all types of credit for small enterprises should be provided by one

agency. The obvious choice would be the NBC which has a branch in each

district but its Act does not permit it to provide credit for purposes other

than working capital.

D: Links Between SIDO-TISCO and the Financial System

12. Tanzania is quite conscious of the technology problems - the problem

of upgrading traditional technology (as in blacksmithy, in which field Tan-

zanian blacksmiths were using a blast furnace technique 1,500 years before it

was invented in Europe) and the problem of selecting, adapting and improving

modern technology. The SIDO is primarily responsible for upgrading tra-

ditional technology and skills, while the Tanzania Industrial Studies and

Consulting Organisation (TISCO) has been set up in 1976 for acquiring skills

in the choice, selection and adaptation of modern technology in the industrial

field.

13. The TIB and the TDFL have evolved economic evaluation criteria and

skills with regard to industrial projects. However, these two institutions

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obviously have not the competence to judge the choices made at the project-

design stage. Since real choices are made at this stage, it is essential

that the function of technical choices be performed by the TISCO, which has

established links with the consultancy centres abroad and is building com-

petence in the field of search for appropriate technology.

14. The TISCO activities, thus, need to be coordinated with the evalua-

tion and financing functions of the TIB and the TDFL; such a link would enable

both sets of institutions to benefit from the resulting economies of scale and

specialisation. What, then, should be the mechanisms for such coordination?

E: Mechanism for Decision-MakingRelating to Interest Rate Policy

15. The Tanzanian financial structure, with sector-wise and term-wise

specialisation of functions, and each function being performed by one institution,

obviously cannot function as a competitive capital market, in which the struc-

ture of interest rates is conditioned by the market forces. The interest rate

structure has to be an administered structure. This raises the question of

the criteria for deciding about this structure. The BOT has the primary

responsibility in this field but the BOT obviously cannot decide about this

issue as well as the other ones related to the volume and allocation of credit'

without an active dialogue with the other financial institutions. Thus there

is a management need for a mechanism to decide about these issues on the basis

of the development objectives and priorities and the interests of the various

financial institutions.

F: Problem of Coordination: AnnualFinance and Credit Plan and Policies

16. Such a coordinating-integrative mechanism is essential for formula-

ting and implementing financial and credit policies. Since tne BOT is the

recognised Leader and the Coordinator of the financial system, and since it

is also responsible for giving active advise on the formulation of the Annual

Finance and the Credit Plan, which it has to monitor, it is essential for

the BOT to evolve some machinery for the purpose of the coordinated and

integrated functioning of the system. What should this machinery be?

III

Discussion of Some Issues of Current Concern

17. There are several issues relating to the role and functions of the

financial system with which the BOT and the other financial institutions are

currently concerned. Some of them are:

(a) What should be the respective roles of the Budget and the

Financial System with regard to resource mobiltsation?

(b) Would saving in the form of financial assets lead to an in-

crease in the degree of inequality in income distribution?

(c) To what extent is there a case for differential interest rate

structure - differential with respect to various sectors?

(d) Is there a case for mobilising financial resources for the

system through the profits of the financial institutions?

(e) How should techniques and methods for formulating the Annual

Finance and Credit Plan be evolved?

We shall deal with each one of these issues in this section.

18. (a) Budget and the Financial System

Tanzania seeks to evolve a socialist and self-reliant economy,

in which a major part of saving would be mobilised through the tax system and

the profits of public enterprises. The question, then, is: is there a role

12 -

for the financial system with regard to resource mobilisation.

19. It is true that the role of the domestic private sector is quite

small in Tanzania. In the field of industry, the private sector is permit-

ted to start enterprises only in fields which are other than infra-structure,

basic capital and intermediate goods and mass consumption goods. It is

somewhat surprising to find that private sector resources, thus, are chan-

neled towards the production of goods and services, which have a low national

priority and are related to the satisfaction of semi-luxury or luxury type

consumption. Such a policy has resulted in the private sector going, into

fields like beer and soft drinks - the resources which could have been

canalised for the satisfaction of more essential and priority needs.

20. The other fields in which the private sector can operate are retail

trade, small enterprises and agriculture. Even with regard to these fields,

the emphasis in policy is towards developing cooperative enterprises, the

assets of. which are jointly owned by the various community groups like the

Ujamaa Villages.

21. In any case, there are a fairly large number of privately owned

enterprises. In addition, there would always be the pure household sector,

which has powerful motives to save. There is, thus, considerable scope for

attracting the surplus profits of private enterprises and saving of the

household sector towards financial instruments. Even at present, the

private sector saving in the form of financial assets is quite significant

by international standards; it farmed about 4-5 percent of GDP during 1976

and 1977, a level that is somewhat higher than that in many LDCs at a com-4/

parable stage of development. Further, there is a limit to mobilising

resources through the tax system without adversely affecting the incentives

to work and to save. Such limit as the Finance Minister recognises in his

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5/1978 Budget speech has already been reached. It may be possible to increase

the overall rate of saving and, in particular, in the form of financial assets

if saving in specified forms - like deposits with maturity of more than five

years with the NBC, THB and the POSB - are exempted from income taxation.

22. The rationale is quite simple. With the high rates of income

taxation and inflation, the household and the private sectors have incentives

to increase consumption and/or save in the form of real goods - which are

also inflation hedges like gold, cattle, land, real estate and scarce com-

modities. This type of saving causes misdirection of real resources and thus

cannot be used for purposes of national development. If these resources can

be attracted towards the financial system, the overall resource-availability

for the development program would certainly increase. Though the private

households may own these financial instruments, the allocation of these

resources would be within the control and discretion of the financial system.

23. (b) Private Savings and Income Inequality

Saving in the form of financial or physical assets would tend

to increase the incomes of savers and since higher income groups would have

proportionately larger savings, income inequality would tend to increase.

But this would be true under any situation where incomes are unequally

distributed. Since even in a socialist society there would be some degree

of functional inequality - in the sense that rewards would depend on the

type of functions to be performed - the question is: would it not be socially

more advantageous to encourage relatively higher income groups to save pro-

portionately more than the relatively lower income groups? Given a certain

inevitable inequality in income distribution, if higher income groups saved

a greater part of their incomes than the lower ones, the disparity in con-

sumption would be less than the income disparity. Further, if such saving

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is mobilised by the financial system, it would be allocated in terms of

national objectives and priorities and thus tend to raise the overall rate

of growth of employment and incomes above what would be attained if such

saving took the forms indicated earlier and resulted in misdirection of

resources. Thus there would be some reduction in income inequality as a

result of higher productive employment and greater increase in labour pro-

ductivity than would otherwise be the case-. Briefly, given an acceptable

degree of inequality of incomes, saving by the private sector in the form

of financial assets would tend to lower consumption disparity and tend,

through greater opportunity for productive employment, to raise the income

levels of the poorer sections of the community.

(c) Level and Structure of Interest Rates

24. In the Tanzanian context, as argued earlier, the structure

of interest rates has to be determined by the BOT. What, then, should be

the criteria and rationale for the interest rate policy?

25. The highest rate of interest obviously cannot be higher than

the expected rate of social surplus or the internal rate of return on mar-

ginal productive investment; the return on the marginal project represents

the opportunity cost of funds. This expected rate of surplus depends on

the desired growth rate of output. For example, if the desired growth rate

of industrial output is 9-10 percent per annum - as it is for Tanzania -,

the expected rate of surplus should be about 15-20 percent per annum, on

the assumption that half to three-fourths of the surplus would be saved and

reinvested. Thus, the cut-off rate for the selection of industrial projects

should be, say, 15 percent per annum internal rate of social return. The

*cost of borrowing obviously should be 3-5 percentage points lower than the

expected rate of return to allow for the effects of inevitable risk and

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uncertainty. Since cost of borrowing depends not only on the rate of interest

but also on real transaction costs of the borrower (cost of negotiating the

loan and other costs related to the timing, duration and adequacy of the

loan), interest rate for term loans to industry should not exceed 10-116/

percent per annum.

26. For agriculture and small enterprises, generally, the expected

rate of return on the marginal projects may be around 15 percent per annum.

The cut-off rate of social return for the selection of projects, thus, may

be around 15 percent per annum. The transaction costs of borrowing for

these sectors are likely to be higher than those for the large industrial

projects. There may not be a branch of a financial institution fairly close

to agricultural operations. There would thus be the cost of distance (trans-

portation costs), opportunity cost of time, and other costs of negotiations

(depending upon the procedures and formalities involved in loan negotiations).

Further, if the loan amount is not adequate or the timing of the loan is not

appropriate (short-term crop loans should be available well before the sowing

season) there would be additional costs (in the form of foregone returns).7/

All these transaction costs may add up to a rate of 2-3 percent per annum.

Allowing for a risk margin of about 5 percent per annum between the expected

rate of return and the cost of borrowing, the rate of interest on agricul-

tural loans should be in the range of 7-8 percent per annum. This rate

could increase to about 10 percent if the real costs of borrowing can be

reduced by appropriate financial innovations.

27. For short-term loans for working capital purposes for industry and

trade, there would not be as high a risk margin as 5 percent per annum. Hence

in principle, and assuming the same expected rates of return, the rate of

interest on working capital loans could be higher than that on term loans.

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28. The structure of interest rates has been viewed so far from the

demand side. One should also view it from the point of view of the viability

of financial institutions - that is from the point of view of the transaction

costs of lending. These transaction costs have two elements - administra-

tive costs and default risk. For large industry, these two costs would

generally add up to about 1.5 percent of outstandinig loans. (This is close

to the TIB record). If to this is added 1 percent profit margin, the total

costs (including profit) would be about 2.5 percent. For working capital

loans, the total costs would be about 2 percent.

29. For agricultural and small enterprise lending, the total costs are

likely to be about 5-6 percent. The TRDB costs are higher at about 6-7 per-

cent because of its high provision for bad and doubtful debts - inherited

from the Agricultural Credit Association and whose recovery was in doubt

even in 1971. Currently with the strengthening of the agricultural credit

machinery, these costs should decline.

30. What about the cost of mobilising resources? The actual mobilisers

of resources are tbe NBC, THB and the social security institutions. Their

cost of funds would vary depending on the interest paid on various types of

saving instruments with which they deal. From the available data, the

average cost of funds (interest cost plus real resource cost of mobilising

savings) seems to be about 5-6 percent. (See Table 3).

31. On the basis of these cost estimates, the lending rate for large

industry and trade (for term loans and working capital) would be in the

range of 7-9 percent, while that for agriculture and small enterprises,

the range would be 10-12 percent. From the demand side, as argued earlier,

the range should be 10-11 percent for large industry and 7-8 percent for

agriculture and small enterprises.

( I I

Table 1: TRANSACTIONS COSTS

(Proportion-Percent-of Total Assets)Adminis- Provision Total trans- Cost of Profits Gross

trative Costs for Risk actions Costs Funds (Before Tax) Income1976 1977 1976 1977 1976 1977 1976 1977 1976 1977 1976 1977

1. NBC - - - - 3.5 3.5 3.0 3.0 4.5 5.5 11.0 12.0

2. TIB 1.3 0.9 0.5 0.5 1.8 1.4 1.0 1.6 3.0 4.0 6.0 7.0

3. TRDB 1.6 1.7 5.0 4.0 6.6 5.7 0.8 1.2 1.6 0.1 9.0 7.0 -

4. TDFL 3.6 3.1 1.3 3.0 4.9 6.1 3.0 3.2 5.1 2.7 13.0 12.0

5. - - - - 6.0 6.0 - - 0.5 0.5 6.5 6.5

6. NDC 3.0 3.0 0.4 0.4 3.4 3.4 2.1 0.7 7.5 8.4 13.0 12.5

Source: Mission estimates based on data available in the Annual Reports of the Institutions.

- 17 -

32. Thus, from the point of view of the viability of the financial

system as a whole, it could afford to lend to agriculture and small enter-

prises only if it can recover the 'potential loss' in such lending by charg-

ing 10-11 percent interest to industry and t.rade.

33. The interest rates on lending can be raised if the transaction costs

of borrowing can be reduced and/or the expected rate of return on investment

can be increased. The major emphasis of the financial system should be on

reducing the total transaction costs in economy; through such new instru-

ments that reduce the transaction cost$ of savers as well as borrowers more

than the increase in the costs of financial intermediation. By reducing

the transaction costs of savers, the cost of funds can be reduced. For

example, a new bank branch in an unbanked area would reduce the transaction

cost of both savers and borrowers, though it would increase the real cost

of intermediation; if the reduction in former costs are more than the increase

in the latter, lending rates can be raised without any increase in the total

cost of borrowing and more saving can be mobilised even without raising the

rates on, say, deposits. Further, if borrowing facilities are offered to

savers for certain purposes - that is if deposits are linked to lending -,

savers get a higher total return on their savings t«han that indicated by the

interest on deposits and thus may be inclined to save more than in the past

in the form of financial assets. The THB 's success in mobilising deposits

is probably due to such a link.

34. The expected rate of return on investments can be raised by linking

credit with technical assistance; such a link would reduce even the trans-

action costs of lending by reducing risk. The cost of technical assistance

can be recovered from the borrowers, if the increase in their returns exceeds

the increase in such costs.

- 18 -

35. (d) Profits of Financial Institutions and Saving Mobilisation

In the previous somewhat hypothetical discussion, we have pro-

vided for a profit margin for financial institutions of about 1 percent on

their lending. The question is: should they have this profit margin, or

should it be passed on to the borrowers in terms of a lower interest?

36. If the financial institutions make a profit, and if it is ploughed

back into the system, it would mean a much higher propensity to save than

that of the borrowers. Further, this increase in the resources of the

financial system would tend to assist new borrowers and new projects. Of

course, this additional saving would materialise even if the borrowers

ploughed back this increase in profits in their own business. But the

additional advantage of this saving remaining with the financial system is

that they would be in a position to allocate these resources in terms of

the national priorities instead of in terms of the priorities of the bor-

rowing public corporation.

37. Moreover, higher interest costs to this extent would tend to

encourage the borrowers to exercise some financial discipline and prevent

them from over-estimating their rates of return.

38. From the point of view of the financial institutions, their

improved financial viability would induce them to be innovative and take

calculated risks in introducing such financial instruments and innovations

that are tailored to the needs and motives of both savers and borrowers.

To be innovative requires some financial independence; this generates con-

fidence to be venturesome.

39. To induce the financial institutions to save their entire profits,

it would be desirable to exempt them from income taxation and make it obliga-

tory on them to transfer their profits to a development reserve fund, which

- 19 -

can be used to assist on favourable terms such projects which may have low

financial retuni but a high social return on the basis of social cost-benefit

calculus.

40. (e) Finance and Credit Plan

It is the responsibility of the BOT to participate in the

formulation of Finance and Credit Plan and to monitor it. The planning

technique for the purpose needs to be progressively refined in the light of

accumulated experience and new data. For the present, this exercise is done

on an ad hoc basis without a permanent nucleus of staff, which can learn

from experience.

41. The technique and procedures for this type of planning, suited

to the current data base, can be briefly indicated. The main object should

be to estimate the total resources of the financial sYstem., the more or less

committed uses and the margin available for manoeuvre with regard to their

allocation. The plan should also indicate the scope for policy action and

the nature and characteristics of the polic-y instruments.

42. The financial domestic resources are mobilised essentially by the

BOT, NBC, THB, NPF, NIC and the PPF (Parastated Pension Fund).

43. One can first try to estimate the resources that can be mobilised

by the BOT and the NBC. The starting point would be the money sypply pro-

jection. It seems reasonable to assume that money supply should grow at

the same rate as GDP; this relationship appears to be fairly stable in the

short-run. The projected money sypply can be decomposed into currency and

demand deposits on the basis of past three years' marginal relationship.

The saving and time deposits of the NBC, POSB and the THB can be related to

the growth of demand deposits; again previous three years' marginal relation-

ship can be used for their estimation. Thus one would obtain the resources

- 20 -

of the BOT, NBC and the THB. To which must be added their expected profits.

44. The growth in the resources of the NPF, PPF and the NIC can be

related to the expected growth of the non-agricultural sector. Their own

expected profits must be added to this estimate.

45. The impact of new developments like new bank branches, new finan-

cial instruments with a different yield pattern, etc. on resource mobilisa-

tion may not be that significant in the short-run but it should be allowed

for on the basis of whatever empirical data and relations are available..

For example, introduction of a 5 year deposit with a yield of 10 percent

per annum could result partly in substitution of other types of deposits

and partly in additional saving in the form of financial assets.

46. The allocation pattern of these resources can be estimated purely

on the basis of past relationships. The bank credit for working capital in

trade and industry, for example, can be related to the expected growth in

non-agricultural output and investment. Such other more or less 'committed'

uses can be estimated on the basis of empirical relationships.

47. The TIB, TRDB and THB can be asked to indicate their resource

requirements for the next five year period with an annual breakdown along

with the resources available from their own profits.

48. The domestic resources available to the government would be derived

as a residual. To this must be added the government surpluses (including

those of public corporations) and the expected flows from the rest of the

world, including use of foreign exchange reserves.

49. If the resulting allocation pattern differs from the desired pattern,

the required policy action for raising additional resources, reduction in non-

essential or non-priority investment and economising on expenditures can be

suggested. In any case, the financial plan should aim at a balance between

- 21 -

the expected resources and the planned investments.

50. This is just a broad outline of the method. In actual practice,

several refinements would be necessary. To start with, the available data

need to be presented in a meaningful way in the form of sources and uses

of funds for each financial institution and for the financial system as a

whole. The relevant relationships then can be identified and analysed with8/

a view to arriving at sound judgments about their nature and characteristics.

- 22 -

IV

Institutional Structure: Integration and Coordination

51. The basic objectives of development have to be decided through a

political process. However, the choice of means and instruments is a

technical task and has to be governed by logic, expertise and intelligence.

The Government obviously cannot be a monolithic institution; it has to

perform several varied functions and each individual function has to be

performed by an institutional machinery that is best equipped to do so.

As in other spheres of human life - social and economic - in the policy

making (in the instrumental sense) field too, there has to be a division

of labour in the light of economies of specialisation and scale, so as to

attain with maximum efficiency and speed the common development objectives.

52. The financial system is a specialized machinery to perform the

functions indicated earlier. Hence it has to function as a system - and

a system cannot function harmoniously without a leader and a coordinator.

This function has inevitably to be performed by the Central Bank; without

that function, there is no rationale for its existence. It has to main-

tain the viability and efficiency of the financial system and widen and

deepen its geographical and functional scope in order to make it an

effective instrument of development with stability.

53. The BOT was expected to "act as the focal point of the monetary

structure with the other credit institutions looking to it for guidance

and direction" - as the Finance Minister said in hIs -1966 Budget speech

on the day following the inauguration of the BOT. However, as the

financial system evolved after 1966 and with the establishment of three

new institutions - TPDB, TIB and THB - the BOT could not act "as the

- 23 -

focal point" as it did not have direct financial relationship with these

new institutions. This situation was changed by the amendmant of the

BOT Act in 1978. This amendment gave powers to the BOT: (a) to provide

short-term accomodation not only to the NBC but also to designated

financial institutions (dfis) like TIB, TRDB and THB; (b) to create

special funds out of its profits to enlarge the resources of these

dfis; (c) to supervise and inspect not only NBC but all other

financial institutions; (d) to call for such information as it considers

relevant for performing its functions from all the financial institutions;

(e) to prescribe minimtum and maximum interest rates on various types of

deposits for all financial institutions; (f) to control the volume,

allocation and terms and conditions of credit given by NBC as well as

the other financial institutions, and (g) to participate in the prepara-

tion, implementation and monitoring of the annual Finance and Credit Plan.

In brief, the BOT is now both de facto and de jure the leader and coordina-

tor of the entire financial system. - /54, The BOT cannot obviously perform these tasks and functions without

a living intimate contact with the system. We recommend, therefore, the

establishment of an Informal Inter-Institutional Group (IIG) under the

leadership of the BOT, comprising the Chariman/Managing Directors of TIB,

TRDB, THB, NIC, NPF, PPS, NBC, SIDO and TISCO. This group should meet, say,

once a month to exchange information, identify problems, discuss and

suggest possible solutions, make decisions and assign specific tasks to

each institution.

55. Such a top management structure for the financial system is

essential for several reasons. The BOT, of course, can ask for such

- 24 -

information as is relevant for its functions from the financial institutions,

but such impersonal mechanisms cannot provide and process all the relevant

information necessary for decision making. To collect and process all

relevant information, besides, is a time consuming as well as a costly

process. Further, what is essential for decision making is a synthetic

synoptic account of quantitative and qualitative information and this can

only be provided through a face-to-face contact among the top management

of the various institutuions. -o/ Mere collection of abundant information is

simply a waste of time and resources if it cannot be processed and condensed

in a meaningful way, relevant to the decision making process. For example,

the recent time consuming discussion and controversy relating to the inte-

rest rate policy of the BOT through notes and memorandum could have been

avoided if all the relevant issues and perspectives were discussed at a

forum like the IIG.

56. Further, the objectives,criteria and methods of the BOT as well

as the other financial institutions are evolving in response to the emerging

situation; this evolving process cannot be captured in written statements.

To ensure that the evolving objectives, criteria and methods of the BOT

and the other financial institutions are mutually consistent, it is.

essential to have a forum like the IIG which would facilitate communication

between the BOT and the other financial institutions. Such communication

is essential for preventing arbitrariness in the BOT decisions that affect

the other institutions.

57. 'Je have deliberately recommended an informal group. If the purpose

is to succeed, it is essential to have a free, frank and constructive dis-

cussion without the need for fozmal statements and records of discussion.

- 25 -

Any formal group would not make this possible.

58. There would be a large number of.decision problems to be discussed

at the IIG meetings. Much would depend on how it functions. Illustratively,

it could discuss the issues of the type mentioned below:

(i) What financial innovations are essential for enlarging the

flow of resources to productive sectors through the financial institutions;

(ii) How to reallocate resources to the priority sectors in the

light of the Fiaance and Credit Plan through the financial institutions

and what policy changes are necessary for the purpose;

(iii) What modifications are required in the level and structure

of interest rates in the light of the emerging situation the relative

rates of return in various sectors and the development objectives and

priorities:

(iv) How to subsidise projects and sectors which are viable on

the basis of social benefit-cost analysis but have a low financial rate of

return;

(v) How to improve the process of project design and formulation

in the industrial sector and what specific role should SIDO and TISCO play

for the purpose. (This is the logic for including SIDO and TISCO in IIG;

in this connection see section VIII on Identification of Project Ideas,

Project Making and Evaluation).

(vi) How to improve the efficiency of the project implementation

process as well as the productivity of operating enterprises and how to

integrate for this purpose the technical assistance by the SIDO and the

TISCO with the financial assistance by the institutions;

(vii) How to improve the criteria and methods of selection,

financing and monitoring of assisted projects in various sectors and how

- 26 --

to ensure their operational effectiveness and efficiency.

59. If the IIG does function as is anticipated, it would reduce the

transaction costs of the entire system and, hence, also of the real sectors.

The qualitative improvement of the decision making process would tend to

increase the efficiency of the financial system. It may be emphasised

that we are not recommending a new institution; we are merely recommending

a mechanism that would improve the functioning of the existing institutions.

60. The rationale for the IIG is equally relevant at the sub-national

level. To facilitate coordination among the activities of the NBC, TRDB,

THB and SIDO (and other institutions like TIB and NIC if they are repre-

sented in the area),we suggest an Informal Inter-Institutional Group at,

say, a regional or district levnl.

61. The effectiveness and efficiency of the IIG at the district!

regional level and, hence, of the institutions, would considerably increase

11/if Area Development Centers (ADCs) - are set up. The rationale for such

an ADC is that it would tend to reduce transaction costs of the institutions,

savers as well as borrowers, and at the same time improve the productivety of

financial insturments. (In this context, please see Section VALI on Efficien-

cy of the Financial System.)

62. Such a Centre would have within its compound offices of the

financial and technical institutions (NBC, TRDB, THB nd SIDO), the agri-

cultural extension agency, companies/corporations selling inputs and

purchasing outputs (of agriculture and small enterprises) and perhaps the

areas's other production and service centers such as industrial estates,

vocational training institutes, health centers, etc. These instituions

have or should have their offices in each area; the crux of our suggestion

is that they be located at one place,. that is easily accessible to the

- 27 -

farmers/small enterprises from the surrounding area. The logic for locating

all these institutions within one center (ADC) is simply to link effectively

the modern sector (i.e. technical, financial and such other services) with

the rural sector by reducing the real costs of acquiring information, of

learning- and of obtaining financial, technical and the other related services

that the rural sector will increasingly require. This reduction in transac-

tion costs and improvement in the quality of services are of great significance

in our view. Even with regard to overhead costs of the institutions, there

would be some saving as a result of establishing some common facilities.

63. If this suggestion is acceptable, we would suggest the setting up

initially of two such ADCs on a pilot experimental basis. Whether this

should be done on a regional or sub-regional level (i.e. district or sub-

district level) will, of course, depend on distances between villages, the

transportation net work and on the spatial distribution of actual and

potential economic activity. Needless to add, the objectives of such

centers should be consistent with the Ujamaa Village program of the

Government. The architectural design of such a center would have to be

worked out in the specific context of each area, the.general specification

being that its location should be such as to be easily accessible to the

farmers/small enterprises/Ujamaa Villages that it seeks to serve. It

should also have a community hall that can serve as a meeting place for

exchanging experience and information as well as a center for socio-cultural

activities. The various serv2'.:.. should be accessible without much cost;

but even this is not enough. ct sl.ould attract like a magnet those whom it

seeks to serve. Hence the community hall for socio-cultural activities.

-- ..............

- 28 -

The design of the ADC should be austere yet elegant, functional yet attrac-

tive, economical yet in harmony with the surrounding landscape and modern

yet consonant with the traditional culture and mores. Its total cost

should be less to the institutions than what it would be if they were not

located at one place; the architect should be able to take advantage of

economies of scale.

- 29 -

V

The Financial System and Domestic Resource Mobilization: An

Assessment and Some Policy Recommendations

64. The central argument of this section and Section VI is that,

as evidenced by the issues of current concern discussed in Section III

above, Tanzania is at a juncture at which experimenting with financial

innovations, both in the mobilization and allocation fields, has become12/

a priority. Numerous reforms have already been taken. In this regard,

the amended Bank of Tanzania Act incorporates a number of important inno-

vations and adjustments that were described in Section I, and various

measures in the field of resource mobilization, described below, suggest

that the challenge has not gone unheeded. Two sub-sections follow: the

first assesses the resource mobilization performance of the Tanzanian economy,

and suggests the need for reforms in this area; the second sub-section des-

cribes the steps in this direction that have already been taken and those

that remain to be tried.

(a) Capital Formation and Resource Mobilization: An Assessment

65. The basic information on capital formation and on resource mobili-

zation is contained in Tables 2 to 8 below. An examination of these tables

suggests a list of questions, the answers to which provide an assessment of

trends in these magnitudes and in their components. These questions are

taken up below:

(i) Is there a decreasing trend in the share of Gross Capital

Formation (GCF) in Gross Domestic Product (GDP)?

66. Table 2 below describes trends in capital formation for the 1966-

77 period, and does suggest that the GCF/GDP ratio peaked in 1971 at 26.4%

- 30 -

and has since declined to 20.3% in 1976, and 17.2% in 1977. However, two

qualifying remarks are in order here: first, that the ratio of Gross Fixed

Capital Formation to GDP shows a slower downward trend; and second, that

the 1977 figur3s are provisional and may or may not be as low as indicated

in the table. Moreover, the 1977 increase in reserves was unusually high at

3.5% of GDP; this suggests not a lack of resources, but a failure to invest

these resources. It is, at any rate, clear that some evidence of a down-

ward trend in capital formation does exist, and this raises questions re-

garding the performance of the domestic resource mobilization systems to

which we turn next.

(ii) What general characteristics emerge from an examination of the

time series on the financing of capital formation?

67. Tables 3 and 4 below describe the levels, shares and ratios

to GDP of domestic and foreign savings. In particular, a distinction is

drawn between Gross National Savings (which include net foreign trans-

fers in domestic saving) and Adjusted National Savings (which include net

foreign transfers in foreign saving). The most salient characteristic of

these tables is the sudden drop in the share of domestic in total saving

in 1974 and 1975, and the equally sudden rise in its share in 1976-77. Thus,

the share of domestic saving in total saving fell from 65.5% in 1973 to 37.3%

and 38.1% respectively in 1974 and 1975, and rose to 84.5 and 77.0% respect-

ively in 1976 and 1977. Nor was this simply because of a sudden drop in

capital formation: between 1974 and 1976 the GCF/GDP fell from 22.0 to 20.3%,

and only in 1977 did it fall to 17.2%. The evidence is clearest in Table

4, where Adjusted National Savings as a percentage of GDP fell from 13.8%

in 1973 to 8.1% in 1975, and then rose to 17.2% in 1976, and dropped back

-31-

to 13.2% in 1977.13/ These data clearly raise the next question: is the

recovery in domestic saving real or apparent?

(iii) Is this remarkable recovery in domestic savings between 1974

and 1976 real or apparent?

68. Such a sudden shift in saving behavior is of course suspect on

an a priori basis since behavioral relationships rarely change suddenly.

But by the same token, the 1974-75 drop in domestic savings from 13.8%

to around 8% of GDP is equally suspect. Clearly savings are a function of

income and other variables and changes in the non-income variables as well

as sudden changes in the income variable are likely to shift the saving-

income relation. A number of hypotheses may be suggested to explain these

changes in the saving ratio. The first of these is difficult, to test for-

mally but has intuitive appeal and can be informally tested. It is hypoth-

esized that the volatility of the domestic'saving ratio primarily reflects

sudden changes in the terms of trade, working their way to the domestic

saving ratio through sudden changes in government revenue and/or expenditure

and private income.

69, The major piece of evidence in favor of this line of thinking is

that the movement of the domestic savings rate is highly correlated with

that of the terms of trade. Thus the terms of trade index (1970=100)

declined from 104 in 1972 to 94, 85, and 78 respectively in 1973, 1974,

and 1975; IS and whiie the 1976 and 1977 indices are yet unavailable, it is

clear that the boom in coffee prices resulted in highly favorable changes

in the index for these years. This improvement in the terms of trade would

be expected to favorably affect both public and private saving. The evi-

dence seems to suggest that most of this saving took place either in the

parastatal sector or in the form of private physical assets: for, data is

only available on government saving and on private financial saving. both

of which increased only slightly (see Tables 5 and 6),

70. A second factor that may have influenced domestic saving is the

inflation record over the 1973-77 period. Thus the national consumer price

index (1970=100) rose from 124.5 in 1973 to 148.4, 187.7 and 200.6 in 1974,

1975 and 1976 respectively.i5/ The forced saving implied by inflation would

be expected to lead to higher government saving and/or parastatal saving

and/or saving of the private business sector, at the expense of household

consumption.

71. A third possible explanation of the change in the domestic saving

ratio, one which suggests that the degree of fluctuation in the domestic

saving ratio is lower than the national accounts estimates suggest, attri-

butes it largely to statistical errors in computing savings. This argument

rests primarily on the discrepancy between the national accounts savings estimate

and that based on an alternative method. The alter.lative method makes

use of data on net increases in the financial assets of the private sector,

to which are added private saving in physical assets (both monetized and

non-monetized) and public saving (both government and parastatal). This

method yields estimates of domestic.savings that differ substantially from

those of the national accounts (see Table 5) I Data availability restricts

us to a comparison of savings data based on the two methods only for 1973

and 1974, and these are as follows:

33 -

Share (%) of Gross Domestic Savings inSource of Estimate Gross Domestic Product

1973 1974

National Accoulnts 13.8 8.2CTable 4)

Table 5 11.5 13.2

7? It is clear that neither of the two estimates dominates the other.

Since the national accounts estimate savings on a residual basis, and the

Net Capital Transfer term in the Balance of Payments Accounts includes Errors

and Omissions, it is entirely possible that given various cyclical phenomena,

the national accounts consistently under- or over-estimate the true

savings ratio. Two possible hypotheses suggest themselves. Firstly, if

the valuation of commodity exports is based on customs data rather than

actual receipts, then under the assumption that customa valuations are based

on immediate past trends, export earnings will be under-estimated at a time

of rising export,commodity prices and over-estimated when export prices

are declining. Since net capital transfers Cwhltch include errors and omissiorns)

are calculated as the difference between the current account deficit and

the change in reserves, the latter method of calculating export earnings

would result in an over-estimation of foreign saving when commodity prices

are rising and vice versa. 17/

73. A second possibility exists and is related to the valuation of

imports over the commodity price cycle. Under the assumption that foreign

exchange crunches generally ensue when commodity prices dip, private impor-

ters with foreign exchange holdings (clearly illegal) would be inclined

to undervalue imports at customs, and would do precisely t,1e opposite when

34

foreign exch3nge allocations are more liberal. In effect, savings take

place abroad at a time of rising export prices and are used up when export

prices decline. This would lead to an underestimation of saving when export

prices are rising, and vice versa.

74, In the absence of firm tests on the relative weights that may be

attached to each of these three factors, one is led to make the safest

assumption, namely, that each has some influence on the saving-ratio

estimate. Thus, to the extent that inflation is imported (and likely

therefore to be cyclical), one may expect to observe a cyclical time-

path for the domestic-saving ratio: similarly, both the terms of trade and export

prices tend to be cyclical. tf that is so, it becomes difficult to

talk of the domestic savings picture at any point of time without speci-

fying the point of the cycle. A simpler way of arriving at an 'average'

picture is to construct stylized ratios for the components of savings by

taking averages over a complete cycle. This is done for the 1973-77 cycle

in Table 8. The question whether the recovery in domestic savings is

real or apparent is thus misleading. The more relevant question is whether

the average domestic savings picture is satisfactory or not, and whether

it is changing favorably or not at the margin.

Table 2 TRENDS IN CAPITAL FORMATION: SELECTED RATIOS 1966-77

1!1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977

Gross Capital Formation 15.5 17.9 17.7 15.5 22.5 26,4 21.7 21.7 22.0 21.1 20.3 17.2GDP Market Prices

Gross Fixed Capital Formation 13.9 16.8 16.5 14.7 20.5 24.2 21.1 20.5 19.0 18.7 19.0 16.6GDP Market Price

Monetary GFCF 16.7 20.2 20.0 17.4 25.1 30.3 26.1 25.0 20.4 19.8 19.1 16.1Monetary GDP

Monetary GFCF 84.7 85.9 86.9 86.8 90.9 92.5 91.5 91.8 92.4 93.7 94.1 93.5Total GFCF

1/ Provisional.

Sources: Economic Survey, 1977-78; Bureau of Statistics provisional figures for 1977.

Table 3 FINANCING OF CAPITAI FORMATION BY DOMESTIC AND FOREIGN SAVINGS

(TSh nmillion in current prices)

- - _ - 1-966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976/a 1977A

(Gross Capital Fornmation 1,092 1,312 1,396 1,286 2,067 2,592 2,439 2,760 3,512 4,004 4,663 4,843

FinaLieL by:

Gross NatLonlal Savings 1,056 1,291 1,243 1,347 1,727 1,717 1,783 1,842 1,632 2,216 4,403 4,689

of wlhichl:

Net Foreign 'rransfers (-9) (52) (76) (76) (92) (41) (-30) (35) (323 (689) (464) (961)

Otler Foreign Savings /b 36 21 153 -61 340 875 656 918 1,880 1,788 260 154

of wlhicll:

Net CapiLal 'Tranisfers/c (410) (93) (205) (-21) (226) (839) (1,046) (1,133) (1,275) (1,625) (827) (1,145)

Increase in Reserves (374) (72) (52) (40) (-114) (-35) (390) (215) (-605) (-163) (566) (991)

ON

Sliares in Capital Finance (%)

Gross National Savings 96.7 98.4 89.1 104.7 83.6 66.2 73.1 66.7 46.5 55.3 94.4 96.8

of wlhiclh:

NeL Foreign lransfers (-0.8) (4.0) (5.4) (5.9) (4.5) (1.6) (-1.2) (1.3) (9.2) (17.2) (10.0) (19.8)

Othler Foreign SaviVs 3.3 1.6 11.0 4.7 16.4 33.8 26.9 33.3 53.6 44.7 5.6 3.2

Adjusted National Savlngs/d 97.5 94.4 83.6 98.8 79.1 64.7 71.9 65.5 37.3 38.1 84.5 77.0

Foreign Savings 2.5 5.6 16.4 1.2 20.9 35.3 28.1 34.5 62.7 61.9 14.5 23.0

/a P'rovisional.

1) Res ijdu I .

/c TncltcI jiug errors an-td omissions.

/tl Net foreuigllt ranlsfers classi tied as foreign savings.

Sour'es: Econioiiic SurveY 1977--78; National Accounts 1966-74; Bureaui of Statistics, provisional figures for 1976-77.

Ax

Table 4: Fl1IJANCING OF CAPITAL FORMATION BY DOMESTIC AND FOREIGN SAVINGS(as percentage of GDP at market prices)

1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977

G.ross CaipiL1l F'orination 15.5 17.9 17.7 15.5 22.5 26.4 21.7 21.1 22.0 21.1 20.3 17.2

Fliaitied by:

(Cross National Savins 15.0 17.6 15.8 16.2 18,8 17.5 15.9 14.1 10.2 11.7 19.2 16.6of whlicli:

Net Foreignl Transfers 0.1 0.7 1.0 0.9 1.0 0.4 -0.3 0.3 2.0 3.6 2.0 3.4

Ocher Fore1.gn SavIngs 0.5 0.3 1.9 -0.7 3.7 8.9 5.8 7.0 11.8 9.4 1.1 0.6of Which:

NoL Capila-1 Trao'sfurs 5.8 1.2 2.6 -0.2 2.5 8.5 9.4 8.6 8.0 8,5 3.6 4.1i C C!0W A 11ii I[:a,; ves 5.3 0.9 0.7 0.5 1.2 -0.4 3.6 1.6 -3.8 0.9 2,5 3.5

Ado j ciSt ed NaLtonal Savin&1s 15.1 16.9 14.8 15.3 17.8 17.1 15.6 13.8 8.2 8.1 17.2 13.2

IOL:ioSL Savilfs 0.4 .0 2.9 0.2 4.7 9.3 6.1 7.3 13.8 13.0 3.1 4.0

iO IIL:i; lBased on Table II.

TI'able 5: COMPONENTS OF GROSS DOMESTIC SAVINGS 1973-78

('I'Sh million current prices; % of GDP at market prices)

% of % of % of % of % of % of1973 GDP 1974 GDP 1975 GDP 1976 GDP 1977 GDP 1978 GDP

Gross Domestic Savinig

A. P'ublic Sector 583 4.4 399 2.5 808 4.3

(i) Governmnent /a 83 0.6 -107 -0.7 127 0.7 354 1.5 424 1.5 n.a.

(LI) Parastatals /b 500 3.8 506 3.2 681 3,6 n.a. n.a. n.a.

B. Private Sector

(i) Monetized Activity 674 5.1 1,451 9.1 n.a. n.a. n.a. n.a.

Net Savings in Financial

Assets /c 118 0.9 716 4.5 371 2.0 748 3.3 1,109 3.9 1,296 4.2

Savings in Phiysical Assets /d 556 4.2 735 4.6 n.a. 1,6 n.a. n.a. n.a.

(iI) Non-iinonetized Activity hU, 250 2.0 266 1.6 303

'I'otal (A +- B) 1,507 11.5 2,116, 13.2

/a Blased on National Accounts 1966-74, Table 12; 1975-76 data from respective Annual Plans.

/b Based on Analysis of Parastatal Accounts 1966-75.

/c Based on 'I'able V.

/d Based on National AccotunLs 1966-74, Table 21.

,,

'I'able 6; PRIVATE SECTOR FINANCIAL SAVINGS

(TSlh million, current prices)

1973 1974 1975 1976 1977 1978

TSh %of TShi % of TShi % of TSli % of TSh Xof TSh % of

million CDP million GDP million GDP million GDP million GDP million GDP

A. Increase In FinancialAssets

Cturrency /a - 297.1 228.9 316.9 200.0 235.4

Deposlts:NBC /b 254.5 338.1 379.2 268.9 874.4 454.4

POSB Deposits /c 10.3 13.0 10.3 9.7 19.8 26.0

Covernment Debt /d 59.6 78.3 24.5 12.3 29.1 708.1

NPF /e 60.7 72.4 115.2 132.5 95.4 118,3

NIC If 16.0 21.0 26.6 40.3 52.1 71.5

'Total 281.9 2.2 819.9 5.1 784.7 4.2 780.6 3.4 1,270.8 4.5 1,613.7 5.2

B. Increase in FinancialTiabilitlies It 164.2 1.3 104.2 0.6 413.4 2.2 32.4 0.2 161.8 0.5 365.4 1.2

C. Net FinancialAssets 117.7 0.9 715.7 4.5 371.3 2.0 748.2 3.2 1,109.0 4.0 1,296.3 4.0

(A - B)

/a Bank of Tanzania, Economic and Operations Report, various issues; Increase in private sector currency holdings assumed equal

to 90% of total increase in currency in circulation.

/b Bank of Tanzania, infornmation provided to mission, THB deposits nQt included due to lack of data,

Ic POSB, information provided to mission.

/d Bank of Tanzania, Economiiic and Operations Report, June 1977, Table 20(b), p. 65.

/e Economic Survey, 1975-76. 1977-78.

/f Tnfonration provided to mission, and NIC Annual Reports; defined as net increase in life fund.

lj Net lending to private secLor by NBC, TRDB, TIB, TDFL, based on Annual Reports; NIC, NPF lendings already netted out in A;

1IIh lending not inciuded.

-40 -

Table 7: LENDING BY FINANCIAL INSTITUTIONS TO THE PRIVATE SECTOR(TSh million)

Financial Institutions 1973 1974 1975 1976 1977 1978

National Bank ofCommerce 48.6 -65.5 200.1 -76.0 75.0 205.8

Tanzania Rural Develop-ment Bank 107.6 203.2 100.5 77.3 148.0/a

Tanzania InvestmentBank 4.0/a 5.1 8.1 4.6 5.0/a 6.6/a

Tanzania DevelopmentFinance Company Ltd.Limited 4.0/a 3.9/a 2.0 3.3 4.5/a 5.0/a

Total 164.2 104.2 413.4 32.4 161.8 365.4

/a Mission estimates.

Source: Information provided to mission by Bank of Tanzania and derivedfrom Annual Reports of financial institutions.

- 41 -

-Table 8: DOMESTI" SAVINGS FOR TANZANIA: STYLIZED RATIOS*(percentage of GDP in market prices)

Stylized PercentageShare of GDP*

Gross Domestic Saving a/ 13.8

Public Sector 4.5

Government Saving 1.0

Parastatal Saving 3.5

Private Sector 9.3

Net Financial Savings 3.1

Financial Assets 4.1

Financial Liabilities 1.0

Physical Saving 6.2

Monetized Sector 4.4

Non-Monetized Sector 1.8

a/ Excluding Net Current Transfers from abroad, which are generally addedon to Disposal Income in the Tanzanian National Accounts.

* Averages for 1973-78, or smaller interval as determined by data avail-ability.

42

(iv) How may we interpret the stylized ratios of the components

of domestic savings?

75. Table 8 displays what we have termed stylized ratios related to

domestic savings in Tanzania. Over the 1973-77 period, the average share of

gross domestic saving in GDP was 13.8%, of which 4.5% originated in the

public sector and 9.3% itnthe private sector. Of the latter, net financial

savings were 3.1%, and saving in physical assets were 6.2%. Subject to

a major qualification dealt with below, it must be emphasized that by inter-

national standards, the Tanzanian saving performance is very respectable,

and is by no means below average, as has frequently been claimed. The

average Gross Domestic Saving ratio for low income countries for 1960 and

1976 were 9% and 8% respectively and Tanzania is a member of this group.

Tanzania's saving performance is more representative of the middle income

countries where average gross domestic savings ratios were 14% and 20%,

respectively for 1960 and 1976. 1l

76. The only qualification that must be made to the above interpre-

tation relates to the view that the post-1973 terms of trade cycle may

differ significantly from previous similar cycles because of the oil-price

increase and its repercussions on import prices in general. If this is

so, tihen it may be argued that the coffee price boom has permitted the

Tanzanian saving performance to attain earlier levels, but that the real

adjustment to the significantly higher import prices of the post-1973

era will take place when coffee prices begin to decline, as they already

have. This would be expected to lead to a decline in domestic savings

43

different from that which would occur during a normal terms of trade cycle.

Thus it may be argued that the above stylized rat4n's, being averages, fail

to reflect savings behavior at the margin where it is likely to be

deteriorating.

(v) What is the overall assessment of the Tanzanian domestic

saving performance?

77. The preceding discussion indicates clearly that the Tanzanian

domestic saving performance has been above average for a low income country,

but may at the margin be deteriorating since its long-run terms of trade

picture has worsened since 1973. That the stylized ratios of Table 8

do not reflect this decline of savings at the margin is to be expected since

the 1976-77 period has been characterized by unusually favorable export

prices. This is one reason why one may claim that Tanzania is at a critical

juncture at which a reassessment of its financial technology is warranted.

True, the terms of trade changes call in the first instance, for a strategy

of adjusting production to the new price structure. But the latter is a

broader question which we cannot address here. The fccus of the present

effort is in suggesting ways in which the long-term ratio of gross domestic

savings to GDP may be increased, a subject to which we turn below,

78. A second reason for reassessing the Tanzanian domestic resource

mobilization has to do with the self-reliance objective: it is generally

conceded that the latter objective requires a concerted effort at increasing

the share of domestic savings in the total financing of capital formation.

This effort must clearly receive greater priority at a time when the self-

reliance (in savings) objective seems threatened,

- 44 -

(b) Measures to Improve the Domestic Regource Mobilization Performance

79, Domestic resource mobilization is, of course, the sum of private,

public and parastatal saving. The emphasis in this report is primarily on

private saving, and within the latter, on private financial saving. Clearly

it is not only important to increase total saving, but in a socialist economy

in particular, to increase the share of financial in total private saving:

for the greater control over the disposition of financial assets is an

important aid in the planning process.

80. Saving and flow-of-funds data comparisons across developed and

developing countries suggest the crucial importance of household sector

saving for financing the saving deficits of the government sector and the

private corporate sector. Given that the saving surplus of the household

sector that can be potentially transferred to the other two sectors is

represented by the household sector's financial saving, the proportion

of the latter in total saving assumes great significance. The data suggest

that with the evolution of financial institutions, the household sector

prefers to hold an increasing share of its savings in the form of financial

savings.

81. Cross-country comparisons of the structure of the household

sector's financial savings shows 19 (a) that it prefers to hold more than

50% of its financial savings in the form of money and deposits; and (b) that

the second significant preferred asset seems to be claims on social security

institutions--life insurance, pension and provident funds, etc. The data

suggest an evolution towards a financial structure in which indirect finan-

cial saving (saving in the form of claims on financial institutions) gains at

45

the expense of direct saving (in the form of direct claims on the government

and corporate sectors), and in which borrowing increases in importance.20/

82. It seems desirable for Tanzania to assist this trend and concen-

trate efforts on facilitating those changes in financial structure that will

make more likely the predominance of an indirect, institutional and largely

contractual flow of personal savings. Such a strategy implies a number of

policies directed at tapping the full potential of saving by the household

sector.

83. The primary determinants of household saving (both physical and

financial) are: (i) opportunities for private investment; (ii) the saving

habit and its inculcation; (iii) the return to saving; and to some extent

(iv) the presence of compulsory/contractual saving. These categories

provide a useful framework for the discussion of policies to im.prove the

mobilization of household saving. In particular, it is important to note

the possible existence of complementarity and substitution between various

forms of saving. But before discussing policy measires, an assessment of

recent trends in financial saving in Tanzania is in order.

84. Table 6 summarizes the evidence on financial saving for the

1973-78 period. It is clear in the first place that the total growth of

financial assets is a more stable variable than is the increase in net

financial assets, a fact which suggests that lending to the private sector

is a frequently used policy variable. The share of gross increases in

financial assets in GDP has, in recent years, hovered around 4%, while

net increases in financial assets varied between 2 and 4.5%. The former

figure reflects the potency of the financial system, and compares very

- 46 -

favorably with other countries at similar income levels. The same is

true of saving in physical assets which (see Table 5) seems somewhat stable

at around 6%.

(i) The'EEffets of 'I 9etmeffl 'TDerd'iztg 'ciiw'Saving

85. There are in Tanzania a large number of household enterprises

in the farm and the non-farm sectors, From the point of view of employment,

income distribution and balanced regional development, it has been the

government policy to support and encourage the development of such enter-

prises. SIDO as well as TRDB owe their origin to this policy. In the field

of medium and large industry, however, private enterprise is encouraged only

in those field not reserved for the public sector (on this issue please

see Section II).

86. Active promotion of such enterprises--whether owned by individuals

or families or cooperative groups--would give a direct and powerful incentive

to the households to save with a view to invest in their own enterprises. In

this sector, saving and investment are directly linked and both would in-

crease with appropriate government policies in the field of credit and tech-

nical assistance (please see Section VII).

87. The role of credit is crucial in the promotion of such enterprises.

In quite a number of cases, household would not have adequate resources to

purchase the required machines and tools and even raw materials. If these

inadequate own funds are not supplemented by credit, the households may not

have the required incenti've to invest. Households, however, would have a

powerful incentive to save if they are assured of the needed supplementary

- 47 -

credit required for initial investment. Thus adequate credit for viable

projects would induce households to increase their own saving for financing

the-r projects. This, in fact, is the logic of linking deposits with

lending.

88. It may be mentioned that this strong motive to save can operate

only in a policy environment that seeks to support and encourage such

non-government enterprises, one crucial requirement for which is a clear and

stable policy environment.

(ii) Household Saving and its Relationship to Accessibility of

Saving Instruments

89. It is clear from international comparisons that thrift deposits--

saving and fixed deposits--are a K.- eferred asset. In this regard the

accessibility of saving instruments to households can hardly be over-

emphas4zed. The implications for branch expansion are clear. Equally

deserving of emphasis, however, is the fact that savers are likely to

prefer a financial instrument that is simple and convenient, that

involves low transaction costs and that is relatively liquid. Interest-

bearing deposits of various maturities are such a financial asset.

However, to make them attractive to savers, these deposit schemes should

be linked to the motives to saving of households,

90. On both fronts--branch expansion and deposits linked to motives

to save--much effort has been made in Tanzania in recent years, and it is

hoped that these efforts will continue. It is difficult to assess the

impact of branch expansion on the growth of deposits, but available

evidence does indicate a positive relationship. 2y Thus, partly as a

- 48 -

result of the NBC's branch expansion effort the poorer regions (regions

other'than Dar es Salaam, Mwanza7 Arusha and KtimanjaroT showed a l3,4% rate

of growth of depbst±ts beatween 1967 and 1,975, while the latter three'regions

recorded 11.1%. C&' highest rate was recorded'by Dar es Salaam--18.4%.) 22/

These findings would suggest that an aggressive branch expansion program,

if continued, is likely to contribute to the growth of deposits, in parti-

cular of saving deposits. 2.4 Should the economics of branch expansion

constrain this effort on the part of NBC, it would be worth considering

some modification of the POSB's deposit schemes so as to exploit its

wider branch network more than hitherto.

91. Much ingenuity has been shown by both the NBC and the POSB in

devising saving instruments that are tailored to the motives of savers.

Perhaps the most successful of these is the POSB's "wadu" scheme. But

also important are the NBC's various schemes: the pay-day collections,

the saving and credit scheme for villages, the money-box scheme, the

estate agent's scheme, etc. What is important to note is that such

schemes must continue to be devised, tried and modified u.'ntil an inte-

grated set of financial instruments, catering to all the saving motives

of Tanzanian households is fashioned.

92. It is worth noting here that one form of deposits that has

been attractive in other countries may be worth trying in Tanzania,

namely lending-linked deposits. In such schemes, deposits are required

to be held with a financial institution and are linked to loans from

that institution. For example, the THB may require that every borrower

first build up deposits of (say) 20% of his/her desired loan. When the

- 49 -

loan is made, it is for the whole amount, so that the deposit is not

liquidated. Thus repayment of the loan results in additional

savings. At any rate, the expectation that a loan is guaranteed when

one's deposits attain some pre-specified level is likely to induce

some additional savings. In this respect, there is some indirect

evidence to support the view that such schemes will work in Tanzania.

Wagao's study slnows that domestic lending has a highly significant

positive effect on the growth of total deposits.24/

(iii) The Return to Saving

93. Recent policy changes in Tanzania also recognize the possible

influence of the level and structure of interest rates on saving behavior.

Since changes in these rates have been infrequent, it is difficult to

assess the interest elasticity of savings.25/ Notwithstanding this

provision, the May 1978 Schedule of Interest Rates is commendable on at

least two counts. In the first place, it reflects a general upward

revision of interest rates on saving and fixed deposits of between 1/2%

and 1%. Such an increase in interest rates is desirable primarily

because of the higher rate of inflation since 1974. More importantly,

the new schedule of interest rates introduces changes in the structure

of interest rates for deposits of different maturities. In particular,

one- to two-year deposits at the NBC now pay 6% instead of 5%, two- to

three-year deposits at the NBC pay 6.5% (these rates were already appli-

cable to THB) and a new category of deposits--from three to five years--

has been introduced at NBC, THB, and POSB, paying a rate of 7%.

- 50 -

94. While the principle of widening differences in the interest rates

on deposits of different maturities seems to have been accepted, there is

some danger that the very sa,all difference between the interest on a one-year

deposit (6%) and a five-year deposit (7%) may not result in any change in the

structure of saving deposits. A morn serious attempt at eliciting

saving deposits for longer periods must offer a much higher return on

five-year deposits than a 1% premium over the one-year rate. It is

recommended that the prirnciple of differential interest rates for

different terms be put to a test by increasing the return on five-year

deposits above the present rate. On a trial basis, this may be done only

for the THB. Another way of distinguishing five-year deposits from those

of lower maturity would be to make such deposits tax-deductible, although

one might expect this option to be less attractive to the saver than the

higher interest-rate,

(iv) Compulsory and Contractual Savings

95. The NPF and the NIC are the foci of Tanzania s compulsory and

contractual saving scheme. Although such schemes have proved to be

attractive in several countries, questions continue to be raised regard-

ing the degree of substitution that occurs between such savings and

other forms (non-contractual) of saving. Preliminary evidence from

Malaysia suggests that contractual savings not only reduce the erratic

element in aggregate saving, but have a positive impact on private

savings, i.e., the growth of contractual saving has not adversely

affected the propensity to save in non-contractual forms, 2.V

96. This view of contractual saving would suggest that the 1978

increase in contributions to the NPF is to be highly commended: 5% of the

- 51

employee s earnings is contri.buted by the employee and an equal amount

by the employer, the ceiling of 70 shillings having been abolished.

The recently set up Parastatal Pension Scheme, although it allows for

contributions of 7-1/2% on the part of the employer, is unlikely to

contribute to mobilizing any additional saving since employee contribu-

tions remain at 5%.

97. The other institution of this nature is the NIC, which has

registered a remarkable record of growth over the past four years:

between 1974 and 1978, its Life Fund increased from 79 million shillings

to 286 million shillings. It would seem that the NIC is an effective

mechanism of mobilizing resources, subject to the caveat regarding

substitution between various financial assets.

98. In spite of the laudatory performance of the contractual

saving inistitutions in Tanzania, and their expected improvement following

the July 1978 amendment in rates, there is one policy measure that could

induce additional savings in this area: namely, making all life-insurance

premiums and all voluntary (i.e., in excess of compulsory) contributions

to the NPF and the Parastatal Pension Scheme tax-deductible.

(iv) Parastatal Saving

99. Tables 5 and 8 indi,cate that parastatal saving aVerages

out at about 3.5% of GDP. This is a substantial part--24%--of the

domestic surplus, but its assessment is a major undertaking that is

beyond the scope of the present report. However, there is a minor

policy recommendation that may be offered here, because it relates to

the mobilization of financial saving, namely, awarding some percentage

-52-

of parastatal employee bonuses in the form of National Saving Certifi-

cates or Fixed Deposits. This is simply another form of compulsory

saving, and is subject to the substitution caveat mentioned above.

(v) A Summary of Policy Recommendations for Increased Domestic

Resource Mobilization

(1) A clear and stable credit policy with respect to non-government

Investmn6ts. and itt`p6ssiSble complementary,

effect on private saving.

(2) Extending the branch/agency distribution network, particularly

in line with the extension of rural development

projects.

(3) Continued experimentation with new deposit schemes,

but with close monitoring of their relative success;

introduction of a lending-linked deposit on an

experimental basis.

(4) Introduction of a five-year fixed deposit with a

rate of interest of (say) 10%.

(5) Allowing tax-deductions of:

(a) Voluntary NPF contributions by employees

in excess of statutory contribution.

(b) All NIC life insurance policies.

(c) Five-year ftxed deposits-,

(6) Awarding some part of Bonuses to Employees in the

form of National Saving Certificates or Fixed Deposits.

- 53 -

VI

The Allocation of Domestic Resources: An Assessment and Some Policy

Recommendations

100. The suggestion that some modification of Tanzania's financial

technology is warranted by recent events applies with even greater force

to the allocation of domestic resources than to their mobilization. For,

as Section V made clear, many constructive reforms have already been under-

taken in the latter arena, but this is not so for the former. The alloca-

tion of domestic resources is guided by the Development Plan, the Annual

Finance and Credit Plan, and the evaluation criteria of the financial

institutions. Thus, as in the case of mobilization, allocat4on is

guided by command-type decisions as well as by market-related (i.e.,

project) evaluations. The instruments through which this allocation

takes place (other than private own-inivestments) are: the Development

Budget, the investment of Parastatal surpluses, Project Lending by

Financial Institutions and Working Capital Loans by the NBC. The ensuing

discussion relates only to the latter two instruments, since our primary

interest is in the financial system.

101. Two central recommendations are offered here: first, that some

degree of stability be introduced in the supply of domestic resources to

the financial institutions, namely, TIB, TRDB and THB. This is deemed

essential to permit better planning of their future activites by the

financial institutions. Secondly, it is recommended that an increasing

share of the domestic resources mobilized be channelled through the

project evaluation expertise of these financial institutions. The

- 54 -

financial institutions are a primary storehouse of the nation's project

evaluation expertise, and this recommendation aims at subjecting all major

investments to their scrutiny. Of course, much the same result is achieved

if every major investment is partly financed by these institutions, since

an independent evaluation would then also be made. This and three other

policy recommendations for the allocation of resources are described

below.

(i) Allocation Quotas for TIB, TRDB and THB

102. It is well established that both TIB and TRDB obtain a large

proportion of their resources externally,27/ and these, by definition,

show much variation from year to year. Moreover, there is much varia-

bility in the annual grantb and loans received by these institutions

from the Treasury. For example, TIB received 41.7 million shillings in

Treasury grants up to 1975, 39.7 million shillings in 1976 and 77.6

million shillings in 1977. Similarly, Treasury loans to TIB were 27.6

million shillings in 1976 and 10.4 million shillings in 1977.28/ The

picture for TRDB is even worse since it has received no resources from

the Treasury other than equity capital, all other resources being loans and

grants from abroad. THB is, in this regard, the healthiest of the three insti-

tutions because it mobilizes its own deposits, and its dependence on foreign

resources is significantly lower than that of the TIB and TRDB.

103. These observations. point to the desirability of linking the

major resource mobilizers in the economy CNBC, NPF, NIC) directly to the

specified financial institutions (TIB, TRDB, THB). One mechanism for

- 55 -

doing this would be through the sale of TIB, TRDB and THB bonds, at say

one half percent over the Government stock rate. Thus, the NBC, NPF and

NIC may be induced, with available policy instruments, to purchase TIB,

TRDB, and THB bonds. Illustratively, one could aim for resource distri-

bution targets such as:

- NPF and NIC:

-- Government stock 60%

-- TIB bonds 15%

-- TRDB bonds 15%

-- THB bonds 10%

NBC (of total liquid assets):

-- TIB, TRDB and TIB bonds 40%

-- Cash, Government bills,

and stocks 60%

104. The rationale for this proposal is two-fold: it is to increase

the share of domestic resources in the total resources of thle financial

institutions, and in this respect, increases in the resources mobilized

domestically should be channelled through these institutions; and secondly,

it is to provide them with more stable resource-flows and thus aid them in

planning their activities. As indicated earlier, the former objective is

both desirable in itself and allows these resources to be used for projects

that are evaluated independently of the promoters, thus making possible a

more efficient allocation of resources. Moreover, this direct channelling

of resources from the NBC, NPF and NIC to the financial institutions will

- 56 -

not only reduce their demand for Treasury funds, but also the transaction

costs associated with the supply of funds.

105. In general, the flow of resources to the financial institutions

and the allocation quotas described above, ought to be determined in such

a way as to channel a rising proportion of increases in domestic resources

to TIB, TRDB and THB directly. It is expected, in any case, that TIB, TRDB

and THB will increase their dependence on domestic resources and corres-

pondingly reduce their foreign resource dependence in the coming years.

Some increase in domestic resources is expected in the near future as a

result of:

(a) The restructuring of interest rates on deposits;

(b) Increased contributions to the NPF and NIC;

(c) New deposit schemes introduced by NBC and THE.

In addition, further increases may result if some of the- recommendations

made in Section V are implemented. It is primarily these increases, it

is suggested here, that should flow directly to the financial institutions

and then on to the productive sectors.

(ii) Loan Participation by the NBC

106. Since the NBC is the major resource mobilizer in the economy, it

would be prudent to relax a major restriction on its present activities,

namely, the stipulation that it not participate in the loan financing of

projects. A more developmental role for NBC is already envisaged in the

recommendation that it be permitted to buy TIB, TRDB and THB Bonds. This

role will be enhanced even further if the NBC is freely permitted to enter

- 57 -

into co-financing of projects that are being sponsored by TIB, TRDB and

THB. It is well to note, moreover, that some progress in this direction

has already occurred, for the NBC collaborates with the TRDB in providing

working capital needs of agricultural projects. There is no reason why,

should its resources permit, the NBC should not be allowed to finance

longer-term segments of project loans.

(iii) Sources of Finance for Urban Small-Scale Enterprises

107. An important gap in the credit market exists in the industrial

sector: there is no specific source of finance for urban small-scale

enterprises (SSEs). The rural SSEs come under the purview of the TRDB,

while the larger industrial projects in urban centers are financed by

the TIB. However, the TIB has as yet been unable to devise a cost-

effective means of financing small-scale.industries. Since the NBC only

finances working-capital requirements at present, urban SSEs are left with

no definite source of medium or long-term finance. Such medium-term finance

as they receive is obtained from SIDO, on a hire-purchase basis, for machin-

ery only. This neglect of the financing of urban SSEs is clearly at variance

with the priority attached to the sector.

108. It is recommended,therefore, that the NBC play the role of finan-

cing all the credit needs of urban small-scale enterprises--both working

capital and project loans. This will require some additional staffing,

and is clearly an activity that must be planned over a long period. The

rationale for having NBC as the sole source of finance for urban SSEs is

two-fold: first, it provides an identifiable source for project loans for

urban SSEs; and secondly, since SSEs have to obtain working capital from

58 -

the NBC, their transaction costs are lower if they obtain investment funds

from the same source. The importance of reducing the transaction costs of

borrowing that SSEs have to incur cannot be overemphasized: very often, the

level of these costs determine the viability of a project.

109. A final observation is in order here: the NBC must evaluate all

projects independently, even if they have already been recommended by SIDO.

This is a general principle that has been found useful in many countries,

namely that a project must be evaluated independently of the promoter. And

yet, it would be necessary for the NBC to simplify its procedures. in order

to keep project preparation costs at reasonable levels. One device for

facilitating this function of the NBC is an Urban Small Scale Enterprise

Fund which may be set up at the Bank of Tanzania, as discussed next.

(iv) Special Funds at the Bank of Tanzania

110. The Bank of Tanzania has recently set up a Rural Finance Fund

to facilitate the expansion of credit for rural development projects. The

preceding paragraphs amply demonstrate the necessity of a similar fund for

Urban Small Scale Enterprises which would function analogously to the Rural

Finance Fund. These funds, as the amended Bank of Tanzania Act stipulates,

will be financed from the Bank's profits. As the Act also states, other

funds of this kind may be set up as their need arises. In this respect,

an Industrial Finance Fund may be warranted to provide credit to industrial

projects that require funding at subsidized rates, such as those that are

presently financed through TIB's Special Fund.

- 59 -

VII

Identification of Project Ideas, Project Making

and Evaluation

111. In concrete terms, the development problem is the problem of

identifying production possibilities in the light of the development

strategy. This strategy is to improve labour productivity in rural

areas and to link the modern industrial sector organically to the re-

quirements for improved labour productivity in the traditional sectors.

Thus the task of project identification and design, and project making

and evaluation is crucial to the development process.

112.- The problem is: how to perform the'se tasks of identification

of project ideas, project making and evaluation.

113. These tasks are the essence of development. Other countries can

help, but the competence to ask questions and identify problems has to

be developed within the country. Once the project ideas are identified,

the next problem is that of identifying the design of the product, design

of the process and design of the machine. All the three have to be in

tune with local skills, markets, repair facilities and local materials.

It is only after these problems are solved that one would know which

type of consultant and from which country would serve the purpose. If

one does not identify these, problems, there would be temptation to engage,

say, a sophisticated well-known consultant who is likely to suggest inap-

propriate, costly, up-to-date technclogy - product design, process and

machine.

- 60 -

114. Hence TISCO and SIDO have vital tasks to perform. 'They should

develop adequate competence to ask meaningful questions and to search for

relevant solutions. With this competence one can ask for help from any

part of the world; without this competence no help can really help. It

is this competence - competence to make choices - which is the essence of

self-reliance. Machine building industries do not necessarily mean self-

reliance; foreign consultants can set them up without one's learning how

to set them up. Self-reliance in the ultimate analysis means ability,

competence and confidence to identify one's problems, search for solutions

and choose a raLearant solution. Hence design engineering competence and

relevant technol:ul?JLr:al research become the foundations on which a self-

reliant economy :ao be built. With such competence, it would be easy to

establish enterprisIesproducing machines to make machines. Without this,

there would be no self-reliance.

115. The real choices have to be made at the project design stage.

If these choices are riot made rightly at this stage, the use of accounting

prices and economic.evaluation criteria for project selection by the

financial institutions cannot affect these choices; project evaluation

criteria would merely indicate whether the project as formulated is con-

*sistent with these criteria or not. Thus, an organic link between SIDO

and TISCO on the one hand and the financial institutions on the other is

essential; the latter can induce the project promoters to seek the assis-

ct.nce of SIDO or TISCO (as the case may be) for project designing and also

submit for critical examination the technical aspects of projects that

- 61 -

come to them for financial assistance. -/ This link, thus, will ensure

that technical choices are made in the light of the resource-endowment of the

country. The project formulation process thus would improve and so would the

economic rate of return of projects so formulated. The economic evaluation

criteria based on social cost-benefit technique for project selection of

the financial institutions would then be an additional check on the

soundness of the projects.

- 62 -

VIII

Efficiency of the Financial System

116. The efficiency of a financial system depends upon the degree to

which it minimises the real resource costs of lending and borrowing.-9/

These costs comprise: (a) real resource costs to savers in the form of

financial instruments, (b) real resource costs of the financial inter-

mediaries for mobilising resources, (c) real resource costs of lending by

the financial intermediaries, and (d) real resource costs of borrowing.

(b) and (c) relate to the cost of financial intermediation - that is of

the financial intermediaries.

117. A. Intermediation Costs: These comprise administrative costs and

risk, represented by provision for bad debts. For resource mobilisation,

only the administrative costs are relevant. For the NBC, these costs

represent about 1-1.5 percent of total deposits and are quite reasonable

judging from the experience of commercial banks in the other countries.

We do not have cost estimates for different types of deposits. However, on

the basis ox data available for the other countries, it would appear that

the demand deposits and saving deposits would be costlier than fixed

30/deposits.-

118. These costs, however, would tend to increase with a program of

rapid branch expansion in the rural and the other unbanked areas of the

country. At present, the NBC has offices only in District Centres. It

has offices in more than 71 districts and would soon have one office in

- 63 -

each of the 82 districts. In addition, it has more than 3.19agencies. Its

task now would be that of opening branches in villages and towns in each

district to reduce the real costs to the savers. Because of the over-

head costs of new branches and the gestation lag of about 3-5 years to

reach break-even point, the mobilisation costs of the NBC would tend to

increase. This cost increase can be minimised by a wise selection of

new branch locations, decefitralisation of decision making, avoidance of

unnecessary paper work, recruitment of staff with just minimum qualifica-

3/tions and an appropriate system of internal training,-2/and keeping the

cost of buildings to the minimum necessary for bank operations. The

branch expansion program can be justified only if it potentially reduces

the cost to the savers more than the additional costs to the NBC. Similar

logic would apply to the'THB)whose costs, however, would be lower than

those of the NBC as it concentrates by and large on the mobilisation of

fixed deposits.

.19. The mobilisation costs of the NIC appear to be quite high despite

the concentration of its business in large urban areas. The ratio of its

administrative costs (relating to life business only) to the accumulated

life fund is as high as 6 percent. The dividend to the subscribers, hence,

is negligible. It should be possible to reduce these costs to a level below

3 percent by improving the employee physical productivity and with scale

economies. Further, it is worth examining whether NBC offices cannot be

effectively used for erLlarging the NIC's life business; a commission of say

1 percent by the NIC to the NBC may suffice to cover additional costs to

the latter.

- 64 -

120. We do not have the cost data for the NPF and the PPS. Since

provident fund payments are deducted from wages and salaries by the

employers and paid directly to the NPF and the PPS, their costs should

be very low - say, about 1 to 2 percent of the tot- l fund. If they are

more than this level, it would be worthwhile to have a close look at their

cost-structures.

121. The term -lending institutions like the TIB, TRDB and TDFL do not

mobilise resources directly from the savers. It would involve duplication

of costs if they tried to do so. For minimising the total cost of re-

source mobilisation to the economy as a whole, it would appear to be

prudeiit for them to mobilise their resources through suitable financial

instruments from resource mobilising intermediaries like the NBC, NIC, NPF

and the PPS.

122. Lending Costs: The lending costs - administrative costs plus

default risk - of all the institutions excepting TDFL appear to be quite

3Vreasonable by international standards.-ly As a-proportion of total assets,

these costs are: NBC - 2-2.5%; TIB 1.5%; TRDB 5-6%o ; and TDFL 4-5%.

123. The TRDB costs would decline, once effective links between agri-

cul.ural extension agencies, the NBC, the Ujamaa Villages and the TRDB are

forged; the rural credit structure has to evolve these new institutional

links after the dissolution of the cooperative system. The new rural credit

structure is being evolved on these lines.

124. The NBC costs may tend to increase with branch expansion and the

orientation of its lending to small enterprises. These additional costs

- 65 -

need to be kept at the minimum through such measures as have been already

suggested earlier. The lending costs for small enterprises may not increase

significantly, if NBC uses the services of the SIDO effectively for project

selection as well as supervision. A closer working association between the NBC

and the TIB could reduce the costs of financing new medium to large enter-

prises. Since TIB project appraisals are quite sound; the NBC risk would

be lower if these appraisals are available to it. For the TIB, supervision

costs could be lowetr if NBC participates effectively with the TIB in moni-

toring their combinled assistance to various projects; since the NBC would

know how an account: of a firm is operated almost on a daily basis, it is

in a-better position than the TIB to provide.early warning signals, which

are crucial for taking timely action by the TIB with regard to its assisted

projects. This reasoning also applies to the TDFL, whose costs are exces-

sively high.

125. Another crucial link that can reduce the TIB-TDFL costs would be

with TISCO. TISCO Is building skills and expertise with regard to the

technical aspects of project formulation and technical assistance to projects,

experiencing technical/managerial problems. Both TIB and TDFL could use on

a commercial basis the services of TISCO with regard to (a) appraisal of the

technical aspects of projects and Eb). timely technical assistance to projects,

facing problems during their construction and operational phases. The

TISCO skills and expertise need not be duplicated by the TIB and the TDFL,

126. TIB has a special role in financing small ancillary type industries.

The lending costs for small industry are inevitably higher than those for medium-

- 66 -

large ones. However, these costs can be reduced if TIB can induce large

enterprises that it finances to be responsible for (a) form-ulating projects

for small enterprises that are ancillary t6 them, (b) providing technical

and managerial assistance in implementing and operating them, and (c) also

providing financial assistance; TIB in that case can lend to small industry

through its large projects and thus reduce effectively its costs of appraisal

and supervision. A large project should be in a position to charge reasonable

fees for the services that it would render to small enterprises; both would

have common interests in the sound functioning of such an industrial com-

plex, comprising one large project and several ancillary type enterprises.

127. Ultimately, the efficiency of the system would depend on the skills,

expertise and efficiency of the staff at various levels and hence on recruit-

ment and training. Since salary scales would depend upon educational levels,

it may be prudent not to recruit over-qualified staff; further, their pro-

ductivity can be enhanced by appropriate training schemes. Some of the

training schemes would be specific to each type&of institution; however,

for middle and senior level staff, there could be such training schemes

that emphasize the functions of the total financial system with regard to

economic development so that they could appreciate their relative functional

35 /roles in relation to the common objectives of the whole system.- In such

training schemes, the relevant government ministry officials should also

participate; their participation would enable them as well as the officials

of the financial institutions to appreciate and understand their respective

roles and functions.

- 67 -

128. Under the Central Bank Act, it is the BOT's responsibility to

organise training facilities. For this purpose, there is already an

institution - Institute of Financial Management (IFM); BOT with the active

assistance of the other financial institutions should develop IFM on the

lines suggested.

129. Saver's Costs: For inducing.the savers to keep their saving in

the form of financial assets (say, deposits), the latter have to be attractive,

that is, should involve low transaction costs and have a yield comparable

to that on alternative physical assets. The net yield to the saver is

equal to the interest yield (r) plus productivity (p) -/ of the instrument

minus transaction costs (t). The financial instruments, thus, should have

a net yield (r+p-t) higher than that on alter-native physical assets.

130. t comprise transportation costs, cost of time and cost of pr6-

cedures and formalities. All these costs can be reduced if the financial

instrument is easily accessible to the saver. In effect this means that

a branch office of the NBC should be located at a reasonable distance from

the saver. A recent study of the NBC does show the positive impact on

deposits of branch expansion. With a NBC branch, that is easily acces-

sible, other financial instruments like life insurance would also become

accessible, once NBC forges the suggested links with NIC as well as such

other institutions.

131. p depends on the quality of the financial instrument or the

38 /services that are linked with it.- A demand deposit instrument, for

example, enables the saver to make a variety of payments at much less cost

- 68 -

than would be possible with other assets like currency or cattle. Financial

instruments that are linked with lending improve their productivity to the

saver to the extent of the potential gains (psychological or monetary) that

accrue to the saver as a result of the borrowing facility. The following

examples illustrate this gain.

132. B. A deposit with THB that is so linked would enable a saver to have

a house earlier than he could afford otherwise. This could make him save

a larger proportion of his income initially so as to qualify for such

borrowing. If, for example, a saver could borrow the full amount needed

for a house if he accumulated 25 percent of the value of the house as a

fixed deposit, he may be induced to make a greater effort in order to have

a house as early as possible. Alternatively, a house may simply not be

within his time horizon, and he may not save for this purpose at all; it

would take a long time to accumulate the amount required and this time

element may eliminate this motive to save.

133. Similarly a farmer or a small entrepreneur could save more in the

form of a financial instrument, provided after accumulating the qualifying

sum (say 25 percent of the value of his intended purchase of a power-tiller

or a machine), he is in a position to borrow to the full extent of the

value of the power-tiller or a machine.

134. On a similar logic, financial instruments can be linked with

lending for the purpose of medical treatment, children's education, crop

failure, etc. Some instruments could be devised in such a way as to

satisfy the motive to save for old age provision; for example a saver

- 69 -

could have a recurring deposit with NBC for 10-15 years after which he could

be repaid the sum accumulated with interest as monthly payments for the

next 10-15 years.

135. C. Borrowers' Costs: In the case of a borrower too, there would be

all these three elements associated with a financial instrument; interest

cost (r), productivity of borrowing (that is, of the project) (p) and tran-

saction cost tt). t can be reduced if distance and time costs can be

lowered for example, with an easy accessibility of a credit instrument.

p can be increased with technical assistance that is associated with lending;

for example, if the borrower's project is improved as a result of TIB ap-

praisal or TISCO assistance through the TIB, the productivity of his project

(its rate of return) would increase. The institutional effort, thus, should

be directed at increasing (p-t).

136. By raising (p-t) for the saver, there could be larger saving at

the same interest rate; similarly by raising (p-t) for the borrower, there

could be larger investment at the same rate of interest. In technical

parlance, such efforts at raising (p-t) would result in a rightward shift in

the supply curve for saving as well as the demand curve for credit. For

the economy as a whole, as long as the increase in (p-t) for both savers and

enterprises is higher than the increase in intermediation costs of the insti-

tutions, real resources would be released for productive investment. This is

the only crucial test of the efficiency of a financial system - the extent

to which it enlarges the flow of real resources towards productive uses that

are consistent with the development objectives.

- 70 -

FOOTNOTES

1/ In this connection see the following: C.D. Datey, Institutional CreditArrangements Above the Village Level (Bank of Tanzania, 1978) and In-stitutional Arrangements for Agricultural Credit At the Village Level(Bank of Tanzania, 1978).

2/ See V.G. Pendharkar, Establishment of the Bank of Tanzania, (Bank ofTanzaria, 1978).

3/ For a detailed discussion of current problems, see V.G. Pendharkar,The Structure of Banking in Tanzania: A Critique, (Bank of Tanzania,1977).

4/ Please see Table 6 and 8. Saving in the form of financial assets iscurrently about 40 percent of the total private sector saving. Forinternational comparison, see V.V. Bhatt, Some Aspects of FinancialPolicies And Central Banking, (World Bank; Economic Development In-stitute Seminar Paper No.11, 1974).

5/ See Budget Speech by the Minister for Finance and Planning (1978,p.22, para. 59).

6/ See V.V. Bhatt, Aspects of Development Banking Policy (World Bank;Economic Development Institute: EDI Seminar Paper No.12, 1975).

7/ For Kenya, these costs are about 3 percent per annum. They are evenhigher elsewhere. See D.W. Adams and G.I. Nehman, Borrowing Costsfor Agricultural Loans in Low Income Countries, (The Ohio StateUniversity, Department of Agricultural Economics and Rural Sociology:Studies in Rural Finance, 1978).

8/ For a detailed discussion, see V.V. Bhatt, 'Saving and Flow of FundsAnalysis: A Tool for Financial Planning in India', The Review ofIncome and Wealth, (Series 17, No.1, March 1971).

9/ See 'Kenneth Arrow on Capitalism and Society', Business and SocietyReview, (Number 10, Summer, 1974). Arrow writes: "I've stressedearlier the information element - that links in the chain of com-munication are in part human. They have to be human because humantransducers are incredibly efficient in certain ways, though veryinefficient in others. They are relatively poor in arithmetic, butthey are very good at integrating disparate pieces of information.There is no likelihood that they will be replaced. So long as theyexist, the qualities that make human beings differ from each otherand that impede or enhance communication among them will be important."

10/ See V.V. Bhatt, Structure of Financial Institutions, (Vora & Co.,Bombay, 1972), Chapter I.

11/ For a discussion of the relationship between the financial systemand the Technology Consultancy Service Centres (TCSCs) and the vitalsignificance of an appropriate technology pr.licy for the developmentprocess, see V.V. Bhatt, Financial Institutions and Technology Policy,(World Bank: Development Economics Department: Domestic FinanceStudies No.54, 1979).

- 71 -

12/ Not surprisingly, attempts at formulating a law of financial develop-ment have continually foundered. For empirical differences in finan-cial accumulation ratios are explained not only by differences inwealth and income across countries, but perhaps more importantly, bythe fact that there are alternative teclniques of mobilizing thecountry's economic surplus, and the financial technique is only oneof them. Moreover, financial accumulation is sensitive to a myriadof other factors: the growth of output, inflation, and not least tohistory, convention and the legal system. Notwithstanding theirrecognition of these facts, Gurley and Shaw have dared to suggest aLaw of Financial Development which is worth quoting: "each economybegins its development by intensive exploitation of a saving-invest-ment technology that is chosen for historical, political, social orperhaps economic reasons, and then, as this technology produces adiminishing net yield, experiments with alternative technologiesthat are marginally superior in terms of their capitalized returnsand costs. Whatever the first choice may be, it is tilled intensivelyuntil there is obvious advantage in trying the extensive margin thatinvolves a mix of processes for eliciting and allocating savings.Along the extensive margin, a socialist society may tolerate marketas well as shadow rates of interest and a capitalist society may putup with some centralized self-finance. (See J.G. Gurley, E.S. Shaw,"Financial Structures and Economic Development," Economic Developmentand Cultural Change, April 1967, Vol. 15, No. 3, pp. 257-68.)

13/ The national accounts estimates suggest an increase in the domesticsaving ratio that is even more striking when account is taken of thecomponents of foreign saving. Foreign savings (see Tables 3 and 4)comprise both net capital transfers and changes in reserves. Theformer fell from around 8% in 1974 and 1975 to around 4% in 1976 and1977, to being round 3% (1976, 1977). This implies that capital for-mation could have been higher if reserves had not been built up (GCFcould have been attained a maxima of 25.3 and 24.5% in 1976 and 1977respectively). Had these maxima been obtained, the adjusted domesticsaving ratios for 1976 and 1977 would have been even higher -- 19.7%and 16.7% instead of 17.2% and 13.2% respectively.

14/ IBRD, Tanzania Basic Economic Report, Annex I, Table 14, p. 33^

15/ Bank of Tanzania, Economic Operations Report, June 1977, Table 28(a),

p. 77.

16/ A similar conclusion is arrived at for the 1967-75 period in IBRD,

22. cit., p. 54.

17/ Although the terms of trade index declined between 1973 and 1974 whatis at issue is the export price index.

-72-,

18/ World Bank, World Development Report, 1978, August 1978, AnnexTable 5, pp. 84-85.

19/ V.V. Bhatt, "Some Aspects of Financial Policies and Central Bankingin Developing Countries," World Development, December 1974, pp. 59-67.

20/ There is, of course, no single best financial system for all times andplaces or even for all countries in the early stages of development.As Cameron writes: "In every case the financial system is related toand must grow out of the distinctive legal, social and politicaltraditions and the economic conditions of its specific environment."However, as he further notes, "(on) the other hand it is true thatnations in the early stages of industrialization face many similarproblems. Although the solutions to these problems may differaccording to circumstances, there are certain common features inall successful solutions... (m)oreover, some solutions are moresuccessful than others." See R. Cameron, et. al., Banking in theEarly Stages of Industrialization, (Oxford University Press, 1969),p. 290.

21/ See J.H. Wagoa, "Reflections of Some Aspects of the Commercial BankingSector of Post-Arusha, Tanzania: 1967-1975," M.A. Thesis, Universityof Dar es Salaam, June 1976. Regressing branch expansion on deposits,a positive relationship was found by Wagoa. This only demonstratesa positive correlation, not causality. It is, however, suggestive.

22/ Wagoa, op. cit., pp. 38-40.

23/ Wagoa, op. cit., pp. 34-35.

24/ Ibid., pp. 26-27, pp. 31-33.

25/ It is felt by NBC staff that the 1972 increase in interest rates gavea spurt to saving deposits. However, it is also widely believed thatbranch expansion, not the interest rate, is the primary determinantof growth in saving deposits.

26/ K.W. Saito and P. Shome, "The Impact of Contractual Saving on ResourceMobilization and Allocation: The Experience in Malaysia," Studies inDomestic Finance No. 38, Public Finance Division, World Bank, April1977.

27/ Bank of Tanzania, "The Structure of Banking in Tanzania," mimeo,pp. 12-17.

28/ TIB Annual Reports, various issues.

- 73 -

29/ For the significance of the transaction costs in the operation of acredit system, see V.V. Bhatt, Interest Rate, Transactions Costs andFinancial Innovations, (World Bank: Development Economics Department:Domestic Finance Studies No.47, 1978).

30/ ibid.

31/ ibid.

32/ For the significance of internal training in realising social andorganisation objectives, see Herbert A. Simon, AdministrativeBehaviour, (New York: The Free Press, 1976, Chaptern. V and XI).

33/ For data on lending costs of the financial institutions, see V.V. Bhatt,Rate of Interest, Transaction Costs and Financial Innovations (op. cit.);see also K. Anderson Saito and D.P. Villanueva, Transaction Costs ofCredit to the Small-Scale Sector in the Philippines, (World Bank: Develop-ment Economics Department: Domestic Finance Studies No.53, 1978), andC.D. Datey, The Financial Cost of Agricultural Credit, (World Bank: StaffWorking Paper No.296, 1978).

34/ On this, see V.V. Bhatt, Development Banks in the Financial System, (WorldBank: Economic Development Institute: Seminar on Development Bank Manage-ment, January, 1979).

35/ See Herbert A. Simon, (op. cit.)

36/ On the concept of productivity of a financial instrument, see John Hicks,The Crisis in Keynesian Economics, (Oxford, 1974), pp. 4 8- 4 9.

37/ Jumanne H. Wagao, Reflections on Some Aspects of the Commercial BankingSector in Post-Arusha Tanzania: 1967-1975, (University of Dar-es-Salaam,Department of Economics, June 1976). See also C. Rangrajan, Innovationsin Banking: The Indian Experience, (World Bank, Development EconomicsDepartment, 1979).

38/ On various types of deposits linked with saving motives, see V.V. Bhatt,Structure of Financial Institutions, (op. cit., Chapter 4).

AppendixPage 1

DOMESTIC RESOURCE MOBILIZATION AND ALLOCATION: PROJECTIONS FORTHE FINANCIAL SYSTEM, 1979-83

We present in this section the projections with regard to the

resource mobilization and its allocation by the financial system for the

period 1979-83. We have tried to indicate a technique for financial

planning on the basis of data that we could collect and process; this

exercise can be -- and should be -- refined by the Bank of Tanzania by

developing a more comprehensive frame of flow-of-funds data and analysis.

The other purpose of this exercise is to quantify the impact on resource

mobilization and allocation of recent reforms already introduced, and of

our recommendations.

The financial projections are made on two alternative sets of

assumptions: under the first set, all projections are on the basis of

past trends while under the second set, it is assumed that the financial

policy reforms already undertaken as well as those recommendations offered

in this report are implemented during the 1979-83 period. In financial

planning, one of the key links with the macro-frame of the Development Plan

is the relationship between the growth rate of money supply and the pro-

jected growth rate of the GDP. Tanzania's GDP is projected to grow at

6% per annum over the 1979-83 period, and a unitary income elasticity of

demand for money is assumed. Thus in the Monetary Projections in Table A.I

below, the money supply is assumed also to grow at 6% per annum.

Two other assumptions underlie Table A.I: first, that the marginal

ratio between Money Supply and currency in circulation remains the same as

AppendixPage 2

the observed ratio during 1974-77, and second, that bank reserves average

out at 3% of total deposits.l/Total deposits include term deposits, and

the latter are derived on the basis of the marginal relationship between

term deposits and money supply during 1974-77. On these assumptions,

Table A.I below provides projections for the Money Supply and Reserve

Money, and their respective components.

Projections of the mobilization and allocation of domestic

resources by the financial system over the 1979-83 period are presented in

Table A.II. Under Assumptions 1, all projections are made on the basis of

past trends by assuming, in general, that the marginal relationship of the

1974-77 period (or the most recent 3-year period for which data are avail-

able) will continue to hold for all projected increases in the mobilization

and allocation of financial resources.

Under Assumption 2, the policy reforms recently undertaken and

the recommendations offered in this report are assumed to have been imple-

mented. In particular, these include: (a) the restructuring of the term

structure of interest rates on deposits, as a result of which deposits are

expected to increase by 10% 2/ over their projected level under Assumption

1; (b) the restructuring of the social security contributions made by

employees and employers, which would tend to increase social security con-

1/ Also observe the 1974-77 ratio.

2/ The level of increase is essentially a guesstimate; however, the assump-tion that interest elasticity of savings in this range is positive issupported by the fact that the ratio of term to demand deposits inTanzania is rather low by international standards.

AppendixPage 3

tributions by about 25% 1/ (in 1979 and thereafter) over the projections

under Assumptions 1. Together these imply an absolute increase in finan-

cial resources mobilized by the financial system of the order of TSh.461.5

million, or a 9.6% increase, over the projected resources under Assumptions

1.

Assumptions 2 also imply changes in the allocation of financial

resources. These are: (c) 25% of the Bank of Tanzania's annual profits

will be transferred to the Central Government while the other 75% will be

used for the Rural Finance, Urban Small Scale Enterprises and Industry Funds;

and (d) 40% of the increase in NPF, PPF and NIC funds are directed to the

purchase of TIB, TRDB and TWM Bonds.

The fundamental premise underlying Assumptions 2 is that the

recommended links between the financial institutions, the BOT and the net-

work of technological and research centers will be forged. This would not

only make likely a commensurate increase in the demand for credit arising

from projects identified on the basis of economic criteria, but also make

possible an allocation of this credit in accordance with the priorities

of the Development Plan.

Table A.II summarizes the mobilization and allocation of domestic

resources by the financial sector, netting out all intra-sector transactions,

1/ This is a lower bound estimate, the use of which is warranted by thelikelihood that the substitution effect on other forms of saving isnon-zero.

AppendixPage 4

under 'the two sets of assumptions. The purpose of this appendix is purely

illustrative. Assumptions 2 are not sacrosanct,, and the emphasis is purely

on the implied method of financial planning. Refinements in the method

can be introduced as data collection is improved and a flow-of-funds table

for the economy becomes possible to construct. In the meanwhile, the

technique offered here, although rather crude, does provide a framework

for financial planning.

Table A.I: MONEY SUPPLY PROJECTIONS, 1979-83

(in million shillings at 1977 prices)

EstimatedStoc'k as at Stock as at Projected Stock as atJune 1977 June 1979 Increase - June 1983

I. Money Supply 5,461.5 6,136.5 1,610.7 7,747.2

a) Currency 1,950.9 2,086.4 /c 547.6 /c 2,634.0

b) Demand Deposits 3,510.6 4,050.1 /c 1,063.1 /c 5,113.2

II. Reserve Money 2,087.3 2,299.9 604.3 2,904.2

a) Bank Reserves /d 136.4 213.5 56.7 270.2

b) Currency inCirculation 1,950.9 2,086.4 547.6 2,634.0

/a Bank of Tanzania, Economic and Operations Report, June 1977, Table 5, p. 49.

/b Money Supply allowed to grow, in real terms, at projected growth rate of GDP: 6%.

/c Assuming con' ant shares of currency and demand deposits in money supply,calculated on basis ofchanges over 1974-77 (Demand deposit share = 0.66),

Id Allowing for bank reserves at Bank of Tanzania of 3% of projected total deposits, calculated on Ui X

basis of average over 1974-77.

T1I,A1 A 1: I)DOMESTIC0 RESOUIRCE HUUILIZATION ANI) ALIOCATION TriVROUG, TIrE FINANCIAL SYSTEM: 1IO.IEC'IONS FOR 1979-83

(in million shillings at 977 prices)

Prolected Projected Projecled Projected

lnereas±s Increases %I Allocation % Allocation /

SuorceS of IVkkls (AssIJI.ptL uI 1 Shs.ras (AssuMpLion 2' Shares llses of Funds (Assumption 1) Shares (Assumption 2) Sihares

1. laR,k nof Tai.a, . 1. CGvernmnent

i) Currency i. 547.6 11.5 547.6 10.5 1) Central CGv-rnment 2,092.9/k 43.9 1,660.2/u 31.7

11) VrufIlt/I 350.0 7.) 350.0 6.7 ii) Parastatals tl 528.9 11.1 581.8 11.1

2. NB(: 2. Specified Finiancial Institutions

I) loLal DeIDosILts ,1 889.U/c 39.6 2,077.9/i 39.4 (TIB, TRDB, TlBI

JJ) CapILJI aiid Rescrves/d 400).0 8.4 400.0 7.6 i) NBC Luans/w 39.7 0.8 43.6 0.8

ii) Government Loanis anid

3. 'rilil Gransts/n - - -

lii) Sale of Bonds 0.0 0.0 6 9 6

.3

/v 13.3

IlTutal Deposits 64.4/. 1.4 70.8/i 1.4

Li) Capital andl eserves/d 7.5 0.1 7.5 0.1 3. Private Sector/oi) Agriculture/p 39.7 0.8 43.6 0.8

4. lPSI1 ii) Induistry /q 528.9 11.1 581.8 11.1

1) Total Delmusits 32.2/f 0.7 35.4/2 0.7 iii) llousing /r 71.0 1.4 78.2 1.5

iv) Other /s 1,292.3 30.9 1.281.8 24.8

5, NIP and PIl'

13 Contributor's Ponds 1,052.1/g 22.1 I,315.1/J 25.5 4. Other

i) BO` Rural Finance Fund/t 175.0 3.6 175.0 3.3

it) BOT Urban SSE Fuid - - 43.8/w 0.8

/li) BO Industry Fund - - 43.8/w 0.8

I): 1lfe FuLid/lh 425,6 8.9 425.6 8.1

ot;I Vhisestic 4eure7684 Ioo 5 229.9 100.0- 4768.4 100.0 5 229.9 100.0

PLIucrAssu.Iner.as in lR:sonurcs alobilizod

AI4. I *I IC-IS( 461.5

l'e.renI.age 1Icrease 9.6

AppendixPage 7

Footnotes to Table A.II

/a See Table A.I.

lb Estimated at 70 million shillings per year, based on average for 1974-77.

/c Based on marginal relationship, 1974-77, between total deposits of NBCand money supply (multiplier = 1.16).

/d Based on average contribution to reserves, 1974-77.

/e Based on marginal relationship, 1974-77, between THB deposits andmoney supply (multiplier = 0.02).

/f Based on marginal relationship, 1974-77, between POSB deposits andmoney supply (multiplier = 0.02).

/g Estimated to grow at GDP growth rate of 6%, using 1977/78 NPF dataas base (N.B. PPF commenced operation in 1978/79, hence its coverageincluded in 1977-78 NPF base.)

/h Estimated to grow at 20%, based on conservative NIC estimate of growthrate of Life Fund.

/i As an approximation 10% above Assumption 1 projections, to allowfor recent reforms in mobilization instruments, and reccnmendationsin present report.

I/l Twenty-five percent above Assumption 1 projection, to allow for theadditional 2-1/2% employer contributions that applies to the Para-statal Pension Fund.(N.B. This may reduce parastatal surpluses, butincreases the flow through the financial system.)

/k 0.9 (Currency) + 0.5 (BOT Profits) + NPF/PPF contributions + POSBdeposits + 0.8 (NIC Life Fund Increase). Ratios based on statutesand/or 1974-77 marginal relationships. Note: This category includesloans and grants to specified financial institutions.

/1 Estimated as 40% of NBC loans, the latter estimated as 70% of NBCtotal deposits; ratio based on 1974-77 magnitudes. Note: This cate-gory neither includes parastatal surpluses, nor loans to parastatalsfrom the specified financial institutions.

/m Estimated as 3% of NBC loans, the latter estimated as 70% of NBCtotal deposits; ratio based on 1974-77 magnitudes.

/n Included in Central Government category (la), see footnote (k).

Io This category includes NBC and THB lending only; all lending of domesticresources by specified financial institutions is included in category(la); see footnotes (k) and (n).

AppendixPage 8

/p Estimated as 3% of NBC loans, latter estimated as 70% of NBC totaldeposits; ratio based on 1974-77 magnitudes.

/~ Estimated as 40% of NBC loans, latter estimated as 70% of NBC totaldeposits; ratio based on 1974-77 magnitudes.

/r Estimated as 90% of THB deposits, plus 1% of NBC loans, latter esti-mated as 70% of NBC total deposits; ratios based on recent magnitudes.

/s Residual.

/t Estimated at 35 million shillings or one-half of BOT profits perannum, based on the initial contribution to this fund.

/u 0.9 (Currency) + 0.25 (BOT Profits) + 0.6 (NPF/PPF Contributions)+ POSB Deposits + 0.6 (NIC Life Fund Increase). Note: This cate-gory excludes loans and grants to specified financial institutions.

/v Fstimated as 40% of NPF/PPF and NIC funds.

/w Estimated as 12-1/2% of BOT annual profits, see footnote (b),