Macroeconomic and Distributional Implications of Financial Reforms in Myanmar1
1. Myanmar’s financial system is undergoing a rapid transformation. Recognizing the importance of the financial sector in promoting economic and social development, the Myanmar government has given priority to financial sector reform as part of its overall reform program since 2011. A financial sector development strategy (FSDS) has been developed with the assistance of World Bank and the IMF, and a financial inclusion roadmap has been launched. The FSDS envisages a phased approach to financial sector reform, with the initial focus on building institutions and policy tools before liberalization of interest rates can take place. In particular, for liberalization to take place without destabilizing the macro-economy, effective monetary policy tools need to be in place, domestic prices anchored by monetary discipline, and prudential oversight of the financial system significantly strengthened. As a key measure to strengthen monetary discipline a substantial reduction in the government’s reliance on central bank financing is essential (see the companion selected issues paper “Myanmar’s Financial Sector: Strategy and Priorities for Reform”).
2. To prepare for the eventual liberalization of Myanmar’s financial sector, it is also important to understand its impact on economic growth, poverty, and income distribution. A history of economic isolation has left Myanmar with a small and underdeveloped financial market. It has also led to concentration of credit in the public sector and large enterprises in urban areas, leaving agriculture and small and medium-sized enterprises (SMEs) poorly served. Given these salient features of financial markets in Myanmar, a key question for policy makers to ask before financial liberalization is how it will affect income distribution and poverty, as well as overall economic growth. Against this background, this selected issues paper attempts to shed some light on the macroeconomic and distributional implications of financial sector reform, with assistance of a dynamic stochastic general equilibrium (DSGE) model.
3. Some caveats are in order at the outset. The model provides a highly stylized presentation of the Myanmar economy and quantitative results presented below are therefore only illustrative. They should not be interpreted as predictions or forecasts. The results are intended to help gain a deeper understanding of the various economic forces, including those that arise from initial economic conditions, that could shape the outcome of financial sector liberalization. These results would help policy makers understand the potential pitfalls of liberalization as well as its benefits, and hence assist with informed consideration of complementary policies in designing the strategy for the financial sector reform.
4. The paper is organized as follows. After an overview of the current state of the financial sector (Section B), a brief description of the model and simulation scenarios is provided (Section C). Section D presents the simulation results and Section E concludes the paper with a summary of policy implications.
B. Financial Market Development and Financial Inclusion in Myanmar
5. Myanmar’s financial sector has expanded rapidly in recent years but remains in early stages of development. Current levels of formal savings are low in Myanmar, with 62.7 percent of the population do not report any savings and 25.7 percent save at home or with someone they know. The country’s historically high inflation and the restriction on the deposit rate in the range of 8 percent to 10 percent means real interest rates have often been negative, which dampens incentives to save. Given the underdeveloped financial market, bank deposits and gold holdings are the main vehicles for saving. Despite the fast growth in bank deposits and credit in recent years, Myanmar still lags behind its regional peers in terms of financial depth. Deposits were low at 35 percent of GDP in 2015/16, much lower than regional peers such as Laos and Cambodia. Domestic credit was 38 percent of GDP in 2015/16, some 15 percentage points lower than Laos. Credit to the private sector, which has been growing rapidly in recent years, was only 19 percent of GDP in 2015/16.
6. State-owned banks play an important role in Myanmar’s financial sector. Despite the rapid expansion of private banks, four state-owned banks (SOBs) still accounted for around a half of banking sector assets and a majority of bank branches and customers nationwide. However, with their lending mainly targeted at the state sector and large firms, SOBs have failed to capitalize on a booming private sector, and have been quickly overtaken by private banks in both banking deposits and loans. Private banks now have a market share of 64 percent in banking deposits, and 82 percent in banking loans.
7. Access to basic financial services is very low. Partly reflecting previous regulatory limits on bank branching, bank branches in Myanmar are limited. The country has only 3.3 commercial banks branches per 100,000 inhabitants in 2015, fewer than regional comparators such as Cambodia, or other countries with similar per capita income. Over 75 percent of adults do not have a bank account in a financial institution. The majority of the population relies on unregulated lenders, often at substantially higher costs than those offered by regulated lenders, or on family and friends, to meet their need for financial services (UNCDF, 2015).
8. A large share of available credit is destined for the public sector. In 2015/16, 49 percent of domestic credit went to the government, of which 80 percent came from the CBM with the remainder largely from the SOBs, especially Myanmar Economic Bank (MEB). Rural households and SMEs have very low access to credit. While the agricultural sector represents 30 percent of GDP and employs 54 percent of the population, only about 2.5 percent of all outstanding loans are made to this sector.
9. State-owned Myanma Agricultural Development Bank (MADB) is the largest financial institution serving the agricultural sector and the rural community. Although in terms of outreach and number of branches, MADB is the second largest state-owned institution in the banking system after MEB, it is still a relatively small financial institution accounting for only 1.3 percent of total assets in the banking system. MADB receives subsidized credit from MEB as its principal source of funding. Semi-private bank Myanmar Livestock and Fisheries Development Bank (MLFDB) also provides small-scale loans to microenterprises. From the financial inclusion perspective, funding from both banks is limited, and risk management is inadequate. The capping of the lending rate means that banks cannot price risks depending on the customer and collateral (or its availability). In fact, it is estimated that more than 3.5 million farmers are not served by MADB due to lack of land titles (World Bank, 2014). In addition, Myanmar does not have a credit bureau.
10. Rural microfinance in Myanmar is at early stages of development. Rural cooperatives and micro-financial institutions (MFIs) that are active in low-income economies could help overcome barriers to financial inclusion. However, in Myanmar, MFIs and cooperatives still have a limited reach and a very limited product offering. Until recently, MFIs were not allowed to borrow domestically from banks, and foreign borrowing could not incur interest rates of more than 8 percent. With bank lending rates capped at 13 percent, banks have little incentives to lend to MFIs given the high risks involved in microfinance. Private banks have shown little interest in direct lending to micro businesses or farmers because they often lack capacity and expertise for the undertaking and because of high operational costs.
11. Poor infrastructure also hampers access to financial services. The coverage and quality of infrastructure in Myanmar are low compared to other developing countries, including its peers in Southeast Asia. According to the Global Competitiveness Index 2015–2016, Myanmar ranks 134th out of 140 countries in terms of infrastructure quality. Electricity supply and transport networks are particularly poor, and telecommunication is also in early stages of development, although it has developed rapidly in recent years from a very base. The Myanmar authorities plan to tap into the growing telecommunication services to promote mobile banking. Recently, the Yoma Bank, in partnership with Telenor Myanmar and with assistance from the IFC, has launched a plan for mobile banking.
C. Macroeconomic and Distributional Implications of Financial Reforms—A Model-Based Approach
12. The model developed in this study is a Dynamic Stochastic General Equilibrium (DSGE) model that belongs to a family of recent models that have been applied to a number of countries to study the macro and distributional impact of economic reforms.2 It is a small open economy model with multiple sectors and multiple types of households. Once calibrated, the model quantitatively reproduces key macroeconomic trends in the country modelled and replicates key distributional features of household-level data.
A Model of the Myanmar economy
13. The model calibrated to Myanmar reflects the most salient features of the Myanmar economy for the purpose of examining the macro and distributional impact of financial sector reform.3 These features include a very significant role for agriculture, a relatively small manufacturing sector, and a basic financial market. In steady state, the model’s database on private consumption, investment and government expenditures, as ratios of GDP, match the Myanmar data. The composition of the labor force in terms of occupations and sectors is also matched, as well as the composition of consumption expenditure by product. Mobility of labor across sectors and geographical areas involves a cost, and as a consequence, average incomes of different economic sectors differ.
14. The model replicates key distributional features of household level data in Myanmar. Each household is subject to income shocks that are calibrated to reproduce Gini coefficients of consumption and poverty rates observed in Myanmar.4 Moreover, the model is calibrated to match households’ consumption patterns, which enable model simulations to capture the distributional implications of policy changes.
Scenarios of policy reforms
15. Four policy experiments are considered:
- Financial liberalization: the government pursues gradual liberalization of interest rates by allowing the deposit rate to rise by 1 percentage point and reducing the growth of money supply sufficiently to lower inflation by 2 percentage points. These measures lead to an increase in the real deposit rate and makes more financial resources available to the private sector. Figure 1 illustrates this reform where the increase in the real deposit rate from deposit rate 0 to deposit rate 1 (due to the increase in the nominal rate and the reduction in inflation) moves the economy from the equilibrium described by points A to the equilibrium described by points B; measures that help promote a reduction in the share of loanable funds channeled to the public sector move the supply of financial resources from Savings(r) to Savings’(r), and the resulting equilibrium of the economy to the one described by points C.
- Financial inclusion: consists of policy changes in the “financial liberalization” scenario plus easier access to private credit to a larger fraction of the agricultural sector. The latter is made possible by a general reduction (an exogenous change in the model) in impediments to credit to farmers, such as accepting a wider range of assets and income as collateral, relaxing restrictions on banking hours, and establishing a credit bureau. Figure 2 illustrates this reform where granting access to credit for rural households that did not have it before moves the demand curve for loanable funds from Borrowing(r) to Borrowing’ (r), and the equilibrium loan rate from point C to D.
- Higher infrastructure investment: constituted by policy changes in the “financial inclusion” scenario plus the channeling of the higher tax revenues that result from higher economic growth generated by the reforms towards infrastructure investment that improves the productivity of all economic sectors.
- Higher infrastructure investment in agriculture: constituted by policy changes in the “financial inclusion” scenario plus the channeling of the higher tax revenues that result from higher economic growth generated by the reforms towards infrastructure investment that benefits the agricultural sector.
Figure 1:Financial Market for the Private Sector: Financial Liberalization
Source: IMF staff estimates.
Figure 2:Financial Market for the Private Sector: Financial Inclusion
Source: IMFstaff estimates.
D. Illustrative Results from Reform Scenarios
16. Financial liberalization increases savings, private credit, and growth. A higher real interest rate on savings as a result of reform motivates households to save more. More funds available for private credit lead to an upward shift of the supply of loanable funds, and a reduction in the real interest rate on private credit. As a result, investment increases and the industrial sector of the economy expands. As shown in Figure 6, the industrial sector share of GDP increases by 5.6 percentage points. The expansion in the industrial sector boosts labor demand and urban wages, promoting migration from rural areas. A larger and wealthier urban population increases the demand for consumption goods, and overall economic activity increases. This result can be seen in Figure 3 (showing the total change in the private-credit-to-GDP ratios), and Figure 4 (showing the impact of the reform on the annual rate of GDP growth). The total private credit to GDP ratio increases by 2.25 percentage points and the GDP growth rate is nearly 2 percentage points above trend. At the same time, private investment grows by 5.0 percentage points above trend, as shown in Figure 5.
Figure 3.Average Credit to GDP Ratio
Source: IMF staff estimates.
Figure 4.Annual Average GDP Growth
Source: IMF staff estimates.
Figure 5.Annual Average Growth in Macro Aggregates
Source: IMF staff estimates.
Figure 6.Sectoral Composition of GDP
Source: IMF staff estimates.
17. Financial liberalization also reduces nationwide inequality and poverty. These results are shown in Figure 7 (showing the total change in the Gini coefficient) and Figure 8 (showing the total change in poverty rates). The Gini coefficient falls by 1.6 points, and the poverty rate falls by 5 percentage points.5 A closer look at the results shows differential impact of the reform on inequality within the urban and rural economies: urban inequality increases slightly while rural inequality falls. This is the case because the expansion of credit to the private sector benefits disproportionally those that already have access to credit, mostly in urban areas. In the rural areas, the higher demand and prices of agricultural products lead to a higher average income for all rural households. However, this higher income has a proportionally larger impact in the level of consumption of those households that are initially more constrained in terms of their consumption levels, i.e. lower income households. Poverty falls in both rural and urban areas, but the decline is more pronounced in urban areas because the expanding industrial sector is located in urban centers.
Figure 7.Gini Coefficient
Source: IMF staff estimates.
Figure 8.Poverty Rate
Source: IMF staff estimates.
18. Financial inclusion reform increases access to credit for the rural population and has a positive effect on agricultural output and farm income. Other things being equal, greater access to credit by farmers leads to an increase in the lending rate. This reduces the impact of the reform on the urban sector that now has to compete for loanable funds. Figures 3 and 4 show that in the “financial inclusion” scenario both the total private credit to GDP ratio and the GDP growth rate are slightly lower than in the “financial liberalization” scenario. This is because agriculture on average has lower productivity than other productive activities, and as a result, overall demand for credit and output expansion in the economy is dampened somewhat compared with the liberalization scenario.
19. Private credit expansion to the rural sector tends to help more those households that are better positioned to take advantage of increased credit availability. These households are the ones with high levels of productivity, which are typically associated with larger land holdings with better technologies and managerial skills. Because those are usually the better-off households in the rural population, increased credit availability to the rural sector means that rural inequality may go up with this reform. Nevertheless, because this reform increases the average income in the rural sector, it reduces national inequality by reducing inter-sectoral inequality. Figure 7 shows that in fact, both rural and urban Gini coefficients go up, but the national Gini decreases by 1.2 points. Regarding poverty, Figure 8 shows that it falls by 4.4 percentage points nationwide.
20. Using revenue generated by reforms to increase investment in infrastructure can further boost growth, and further reduce poverty and nationwide inequality. Higher tax revenues that result from higher growth generated by reforms can be used to increase investment in infrastructure, amplifying the impact on growth, inequality, and poverty. Figure 4 shows that investing in infrastructure increases the GDP growth rate by at least 0.4 percentage points in comparison with the growth rate generated by the reforms where additional tax revenues are used to finance current government expenditure. Figures 4, 5 and 6 show that the impact of infrastructure investment on GDP growth, private investment growth and GDP sectoral composition depends on which economic sectors benefit from the increased investment. Investment in infrastructure directed to all economic sectors generates an annual GDP growth rate that is 3.1 percentage points above trend, annual investment growth 7.4 percentage points above trend, and the share of the industrial sector in GDP 1.6 percentage points larger than in the baseline. In contrast, investment in infrastructure focused on agriculture generates an annual GDP growth rate that is 2.3 percentage points above trend, annual investment growth 5.4 percentage points above trend, and the share of the industrial sector in GDP 11.0 percentage points smaller than in the baseline.
21. Investment in infrastructure that benefits all economic sectors has a larger positive impact on economic activity, but investing in rural infrastructure leads to a better distributional outcome for the country as a whole. Figures 7 and 8 show that investing increased revenue in infrastructure that is directed to all economic sectors reduces the Gini coefficient (in comparison to the baseline) by 1.8 points and the poverty rate by 6.5 percentage points. In comparison, investing in infrastructure targeted to the agricultural sector reduces the Gini coefficient by 2.6 points, with a similar outcome for poverty reduction at 6.4 percentage points.
E. Policy Implications
22. Financial liberalization in Myanmar—once macro conditions are put in place—can significantly boost economic growth, reduce poverty, and improve nationwide income distribution. Allowing increases in interest rates over time and phasing out the CBM financing of fiscal deficits would ensure positive interest rates in real terms and encourage household savings. Higher savings would in turn increase credit supply to the economy and make more resources available to the private sector, allowing higher investment and hence higher growth. The poor would benefit from higher growth with reduced poverty, but they may benefit proportionally less than the better-off, especially in urban areas where a large informal sector exists.
23. Financial inclusion policies aimed at increasing general credit access for agriculture and SMEs can help further reduce poverty, but may benefit the poor less. In particular, improving credit access for agriculture and SMEs would help expand the productive capacity of these two sectors, but the ability to access finance varies among farmers and SMEs, and hence policies need to target disadvantaged groups in order to improve the distributional outcome of financial inclusion efforts. Well-targeted micro-finance schemes could play an important role in this regard.
24. Policies to improve infrastructure can amplify the positive impact on growth and poverty of financial reform. Given that Myanmar’s poor infrastructure is a key impediment to financial access for the poor, increasing investment in critical infrastructure such as electricity, transport and telecom services, has a policy appeal. However, some trade-offs are inevitable in deciding sectoral priorities for infrastructure investment. Investment in rural areas may not generate the largest growth impact than investment in the more densely populated urban areas, but it would help reduce rural-urban disparity. But again, addressing intra-rural and intra-urban inequality would require policies to target the poorest groups that may not be able to take advantage of emerging opportunities from improved infrastructure.
25. Achieving inclusive growth in the process of financial sector reform will likely require trade-offs between policy objectives. Bringing down inflation by phasing out central bank financing of fiscal deficits would help protect the income of the poor. But as financial sector reform deepens, including through the liberalization of interest rates, the authorities will need to assess possible trade-offs between growth, poverty and distribution objectives and design policies that would help achieve outcomes that are most conducive to Myanmar’s long-term goal of building a prosperous and inclusive society.
The model in this paper is a dynamic stochastic general equilibrium model of a small open economy with multiple sectors. There are a large number of households that are heterogeneous, both within and across sectors. Urban and rural households differ on their occupations as well as on their access to financial intermediaries. Within-sector heterogeneity is due to household-specific shocks to productivity.
Money demand in the model is introduced through a cash-in-advance constraint. As is standard in the literature, we assume that cash is required for obtaining consumption goods.
A fraction of total savings is used by the government to finance its own and SOE operations; the rest goes to financing private credit. We will assume that private investment must be financed. Also, we assume that farmers producing a surplus require an amount of intermediates (seeds, fertilizer, etc.) large enough that it must also be financed. Private investment and agricultural intermediates requirements for credit constitute the total demand for private credit in the economy.
There are four types of occupations in the economy, three urban and one rural:
- Agricultural workers (rural)
- Entrepreneurs (urban)
- Public sector workers (urban)
- Private sector workers (urban)
Households are confined to their sectors and cannot easily switch occupations. Agents face a fixed cost of moving from and to urban areas. This cost is calibrated to reproduce the observed income differential between rural and urban households.
Worker types: Agricultural workers use their labor and intermediate inputs to produce. The product produced can be consumed or sold on the market. Public sector workers work for the government which does not produce marketable goods. Private sector workers provide their labor to the entrepreneurs. Additionally, both private and public sector workers can choose instead to use their time to produce nonfood products, avoiding taxes—this is the informal sector.
The entrepreneurs produce a nonfood item using capital and labor1. This nonfood product can then either be sold to consumers or converted into capital using an intermediary. Each entrepreneurial household owns capital stock which cannot be converted back into a nonfood consumption good. Capital depreciates over time so that new investments are necessary to maintain the capital stock.
Besides the domestically produced agricultural product and the nonfood product, there is also an agricultural export product. The production of this good (e.g., beans and pulses) takes place in firms owned by entrepreneurs. It uses the domestic agricultural product as input which is then refined and packaged using labor.
|Domestic agricultural product||Agricultural workers||Labor and intermediates (seeds, fertilizer, etc.)||Consumption, production of agricultural exports|
|Nonfood products||Entrepreneurs||Private sector labor, capital||Consumption investment|
|Private / public sector workers||Labor – informal production|
|Agricultural exports||Entrepreneurs||Domestic agricultural product, private sector labor||Exports|
Preferences and household decisions are as follows:
- Households live forever and are forward looking. In every period, they decide how much of their disposable income to consume, how much to save in interest-bearing assets, and how much money to hold. Households face uncertainty regarding their future income and are risk averse: they want to avoid large fluctuations in their consumption over time. Having access to a financial intermediary allows them to accumulate a buffer of financial wealth as insurance against future drops in income. Households facing more severe shocks can borrow to smooth consumption if they have access to finance2.
- Households also decide how to allocate their consumption expenditure over two food items (domestically produced and imported) and the nonfood item.
Financial intermediation and financial sector policies
Financial intermediaries have two distinct roles in the economy:
- They finance investment for entrepreneurs, and the purchase of intermediates for agricultural producers, and
- They allow workers to save and borrow.
Fiscal policy parameters
The government in the model has access to a rich set of taxes and transfers to pay the public sector workers and to provide insurance to vulnerable households. These policies are captured by a set of exogenous policy parameters:
- A tax on entrepreneurs’ capital income
- A tax on private and public sector workers’ wage earnings
- Sector specific and means-tested transfers
Each non-entrepreneurial household’s productivity is subject to random changes over time, but these changes in productivity are different across households. At each point in time, some households are lucky while others are unlucky. There is no aggregate uncertainty and, given the large number of households, a law of large numbers applies, so that the distribution of shocks across households within each sector remains constant. That is, the number of unlucky households is always the same.
Equilibrium and steady state
At each point in time, prices, wages, and borrowing interest rates are set to ensure that the markets for all three domestically produced goods, for credit, and for labor clear. Moreover, given these prices (both in the present and future) and government policies, all household decisions are made to maximize the present value of lifetime utility. The prices of imported food and agricultural exports are exogenously given.
The nominal savings interest rate is determined by the government through regulation and monetary policy. However, real interest rates can change with inflation. Additionally, as described before, a part of the savings that private agents accumulate goes towards the financing of government and SOE operations. The leftover part is available for private credit, and the interest rate of credit is such that the credit market clears.
The economy is in a steady state. Aggregate variables and prices are constant over time, as is the distribution of wealth, income, and consumption across households. The income, wealth, and consumption of individual households, however, changes over time with the realization of their idiosyncratic shocks.
United Nations Capital Development Fund (UNCDF)2015Myanmar Financial Inclusion Roadmap 2014-20.
World Bank Group2014. Myanmar agricultural development bank: initial assessment and restructuring options (Washington, DC).
Prepared by Sandra Valentina Lizarazo Ruiz, Adrian Peralta-Alva, Yiqun Wu, and Vinzenz Ziesemer.
Different versions of the model have been used in the Article IV consultations with Ethiopia (2015), Malawi (2015), Honduras (2016), Guatemala (2016), Bolivia (2016), and the Republic of Congo (2016).
Features that are of particular relevance for the analysis include: (i) an economy with fixed nominal interest rate in savings; (ii) high level of inflation; (iii) large participation of state-owned banks in the process of financial intermediation; (iv) low levels of credit to the rural sector.
Most recent information indicates that inequality as measured by the Gini index is relatively low (0.29) and about 38 percent of the population lives in poverty.
Note that inequality is measured by the Gini Coefficient of consumption rather than income.
Hence the nonfood product is produced both within the entrepreneurs’ firms and informally by workers at home.
The model thereby highlights the role of financial inclusion not just as a measure of mobilizing resources for investment but also as an insurance mechanism that reduces consumption inequality.