Abstract
This Selected Issues paper examines the macroeconomic and fiscal implications of natural gas project for Mozambique. Results, which are based on the IMF Fiscal Analysis of Resource Industries model, suggest that, by the mid-2020s, half of the country's output will be generated by natural gas. However, the fiscal revenues from the projects will remain moderate until the mid-2020s because of large depreciation costs for gas liquefaction facilities. Although the economic potential emerging from the projects is tremendous, macroeconomic and fiscal implications are quite sensitive to international commodity price developments and other risk factors, highlighting that the government's authorities would be well-advised in taking a cautious approach.
Monetary Policy, Banking Structure and Interest Rates in Mozambiquemonetary1
Mozambique is experiencing rapid banking sector expansion. The number of bank branches increased from 228 in 2005 to 529 in 2014. While this development was matched by a great effort by the central bank to promote the growth of credit to the private sector, the interest rates on bank lending remain prohibitively high for SMEs and commercial banks’ responses to the central bank’s policy rate adjustments are sluggish. This annex explores the structural factors that may explain this phenomenon and discuss policy implications.
A. Background and Context
1. The main objective of monetary policy is to maintain price stability, with the reserve money being the operating target. Every year the government announces an inflation objective, which is currently defined as a medium-term target in the 5-6 percent range and becomes the Bank of Mozambique’s (BM) inflation objective. Secondary to controlling inflation, the BM also attempts to promote private sector credit growth and financial deepening. The reserve money targets are calibrated through the consideration of broad money and credit growth and the impacts on the interbank interest rates and market interest rates. The BM also uses interest rate adjustments to aid reserve money targeting and help communicate its monetary policy intention to the market—in the monthly Monetary Policy Committee (MPC) meeting, it would decide on any changes to its Standing Lending Facility (FPC) rate and Standing Deposit Facility (FPD) rate after assessing the macroeconomic environment and the inflation outlook, in addition to setting the monthly reserve money target and any change in the reserve requirement.
2. The BM uses a conventional range of liquidity management instruments to achieve its objectives. The main tool is open market operations, which include T-bills auctioned by the BM for monetary policy purposes and repo operations. The BM also uses less frequently the changes in reserve requirements and spot interventions in the interbank foreign exchange market. Reserve requirements apply to all deposits (i.e., local and foreign currency, demand and time deposits), including Government deposits. Banks are required to hold their required reserves on a daily basis, in local currency, and with no remuneration.
3. The underdeveloped domestic capital market prevents a smooth monetary transmission mechanism, making fine tuning of policy stance difficult. During periods of large swings in reserve money growth, the impact of monetary developments on inflation outcome is more discernible; this was for instance the case after the significant monetary tightening in 2011. However, for most periods monetary fine tuning does not seem to exert visible impact on inflation. This could be due to the fact that the banking system tends to be structurally over liquid and that only a small share of the CPI basket is influenced directly by monetary policy (the CPI basket is dominated by food and administered products).
Money, Credit and Inflation
(12-month percentage change)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Money, Credit and Inflation
(12-month percentage change)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Money, Credit and Inflation
(12-month percentage change)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
4. The influence of the policy rates on the interbank market appears to be weak. There is a wide corridor between the two policy rates, FPC rate and the FPD rate, which provides little guidance to movements of the interbank rate. The spread between FPC and FPD rates is currently at 575 basis points after the BM narrowed the width of this corridor in recent years, but it is still much wider than in most emerging markets (typically at about 200 basis points) or advanced economies (typically at about 100 basis points). In practice the FPC is not used frequently by commercial banks. The interbank rate shows very low day-to-day volatility, and anecdotal evidence suggests that the interbank market is dominated by one/two banks that are structurally overliquid in meticals, and therefore can act as de facto price setters and market makers.
5. Furthermore, the market deposit rate is sticky, while the lending rate responds more to the deposit rate than to the policy rates. For example, between mid-2011 and late 2015, the BM cut the FPC rate by 900 basis points cumulatively, while the one-year deposit rate and lending rate only moved by 450 basis points and 500 basis points, respectively. As the deposit base of the banking system is dominated by a few large institutional investors, these depositors are able to shop around for the best rates. This results in a downward stickiness of the deposit rate. Moreover, data, reinforced by anecdotal evidence, suggests that, although some prime rates are linked to the FPC rate, the commercial banks tend to set the lending rates as a markup over their deposit rates, which reflect better their true funding cost than the FPC rate. The stickiness of market interest rates not only hampers the proper transmission of monetary policy, it also constrain implementation of the BM’s strategy of financial deepening—with the high and sticky interest rates, few SMEs are able to afford bank credit and, as a result, the rapid credit growth that the BM has been promoting in recent years tends to concentrate on large borrowers or on consumer loans backed by salaries.
Interest Rates
(Percent per annum)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Interest Rates
(Percent per annum)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Interest Rates
(Percent per annum)
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
B. Characteristics of Mozambique’s Banking Industry
6. Financial access in Mozambique has increased remarkably over the last decade. Representing about 50 percent of the access points to formal financial services in 2014,2 commercial bank branches increased from 228 in 2005 to 563 in 2014, reflecting in part an increase in the number of banks from 12 to 18 over the same period. This expansion of banking access, despite being more pronounced in urban areas, was observed country-wide and associated with a steady rise of private sector credit (Figure 1).
Mozambique: Selected Banking Sector Developments
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Source: World Bank (Financial Development and Structure Dataset, November 2013 update)Mozambique: Selected Banking Sector Developments
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Source: World Bank (Financial Development and Structure Dataset, November 2013 update)Mozambique: Selected Banking Sector Developments
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Source: World Bank (Financial Development and Structure Dataset, November 2013 update)7. However, a high degree of market concentration underpins the financial sector growth in Mozambique. The top 3 largest commercial banks accounted for 83 percent of total banks’ credit in 2011. Credit concentration is high not only compared to relatively more developed countries in the region (e.g. Mauritius and Botswana), but also compared to countries at a similar development stage such as Tanzania, Zambia and Congo (Figure 1). Although the degree of concentration has declined over time, it did so at a relatively slow pace. While Zambia and Botswana have experienced a consistent decline in concentration over time, in 2011 Mozambique exhibited the same concentration level as in 1998 (Figure 1).
8. Domestic customers’ deposits constitute the main funding source for the commercial banks. Banks’ incentives to use the central bank’s lending facility, the interbank market, or foreign credit lines for liquidity appear to be limited as: (i) there is a maturity mismatch between the central bank lending facility (overnight) and commercial bank loans (longer maturities); (ii) big and small banks exchange only a fairly low level of liquidity in the interbank market, which partly reflects banks’ risk aversion to increase exposure to each other; and (iii) foreign credit lines to banks (in the form of foreign currency) not only are very limited in size, but also subject banks to prudential regulation restrictions that discourage lending to non-exporters and in foreign currency.
9. While playing a key role in banks’ financing, the deposit base is very narrow and also concentrated among a few large institutional clients, including public companies and non-bank financial institutions (NBFI) comprising pension funds and insurance companies. These clients’ share in the total banking system’s deposits has grown substantially since 2005, reaching 20 percent in mid-2010, before stabilizing at 15 percent at end-2014 (Figure 1). This concentration level is high if one takes into account that there are only 14 public companies, 2 large pension funds and not more than 10 large non-bank financial institutions. Market participants claim that the share is much higher for many individual banks. These institutional depositors could largely dictate their interest rates and are driving the marginal costs of the banks. On the other hand, with a deposit-to-GDP ratio at 33 percent at end-2011, Mozambique ranks far below Mauritius (90 percent) and South Africa (59 percent) in terms of financial resources available for banks’ intermediation. It only performs marginally better than Angola, Tanzania, Malawi and other SADC low income economies (Figure 1).
10. There are concerns that high market concentration may be contributing to the observed high lending interest rate as excessive concentration in credit and deposit could grant high pricing power to large banks and depositors. In fact, the average lending interest rate has declined gradually over time but, at close to 19 percent for one-year maturity in late 2015, it remains among the highest in the region. This is despite pronounced cuts in the central bank’s policy rate over the last years (Figure 1). In the next section, we attempt to assess whether the lending interest rate is correlated to credit and deposit concentration over time.
C. Assessing the Effect of Credit and Deposit Concentration on the Interest Rate
11. Staff assessed the impact of credit and deposit concentration on the average lending interest rate over the period 2002M1-2014M12 through a regression analysis.3 The results are reported in Table 1 from which we highlight the following:
Regression Results
Regression Results
| Dependent variable: average prime interest rate on bank loans for 1-year maturity (percent) | ||
|---|---|---|
| Regressors | Coef. | Std. error1 |
| Concentration of public companies' and NBFI deposits (percent) | 0.24** | 0.09 |
| Concentration of top 5 banks' credit (percent) | 1.20*** | 0.01 |
| BoM's policy interest rate-FPC (percent) | 6.21*** | 2.01 |
| Interaction of FPC with credit concentration | −0.07*** | 0.02 |
| Reserve money y/y growth (percent) | −0.11*** | 0.04 |
| 12-month end-of-period inflation rate (percent) | −0.06 | 0.08 |
| Reserve requirement rate (percent) | 0.95*** | 0.26 |
| Constant | −99.22 | 38.35 |
| Adjusted R2 | 0.81 | |
| F test | 102.09 | |
| Observations | 156.00 | |
Regression Results
| Dependent variable: average prime interest rate on bank loans for 1-year maturity (percent) | ||
|---|---|---|
| Regressors | Coef. | Std. error1 |
| Concentration of public companies' and NBFI deposits (percent) | 0.24** | 0.09 |
| Concentration of top 5 banks' credit (percent) | 1.20*** | 0.01 |
| BoM's policy interest rate-FPC (percent) | 6.21*** | 2.01 |
| Interaction of FPC with credit concentration | −0.07*** | 0.02 |
| Reserve money y/y growth (percent) | −0.11*** | 0.04 |
| 12-month end-of-period inflation rate (percent) | −0.06 | 0.08 |
| Reserve requirement rate (percent) | 0.95*** | 0.26 |
| Constant | −99.22 | 38.35 |
| Adjusted R2 | 0.81 | |
| F test | 102.09 | |
| Observations | 156.00 | |
12. Deposit concentration has a significant effect on the lending interest rate: all else being equal, each 10 percentage point increase in public companies’ and NBFI’s deposit concentration ratio is associated with 240 basis points increase in the lending interest rate on average. This suggests that, among other factors, high deposit concentration, especially in small and medium-sized banks, may be an important driver of the lending interest rate behavior in Mozambique.
13. Credit concentration significantly affects the lending interest rate, but the impact depends on the monetary policy stance. The higher the central bank’s lending interest rate, the lower the effect of credit concentration and vice-versa. Assessed at the median policy rate over the sampled period (14.5 percent), the coefficient of credit concentration is estimated at 0.19. This suggests that, other things being equal, each 10 percentage point increase in the credit concentration ratio is associated with 190 basis points increase in the lending interest rate.
Excessive credit concentration potentially generates sizeable interest rate costs. We illustrate this by estimating model-implied interest rates assuming lower credit concentration levels than actually observed in Mozambique. All else equal, the interest rate could be around 600 basis points lower if Mozambique’s credit concentration level was similar to South Africa’s (Figure 2)
Impact of Credit Concentration on Interest Rate Under Hypothetical Concentration Levels
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Impact of Credit Concentration on Interest Rate Under Hypothetical Concentration Levels
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
Impact of Credit Concentration on Interest Rate Under Hypothetical Concentration Levels
Citation: IMF Staff Country Reports 2016, 010; 10.5089/9781513539065.002.A002
14. High credit concentration weakens the effectiveness of monetary policy. The central bank policy interest rate does have a statistically significant and positive effect on the market lending interest rate, but the pass-through is constrained by the degree of credit concentration. The higher the credit concentration, the lower the effect of central bank’s lending rate.
D. Conclusions and Policy Implications
15. High deposit and credit concentration could be part of the reasons contributing to the high lending interest rate in Mozambique. Not only higher credit and deposit concentration is associated with higher lending interest rate, but higher credit concentration also appears to weaken the effectiveness of the central bank’s policy rate adjustment. This finding is consistent with the Structure-Conduct-Performance theory, according to which highly concentrated banking industries tend to enjoy lower competition, leading to higher interest rates and reducing banks’ incentives to respond to monetary policy stimulus. The findings suggest two policy implications:
Promote an environment for greater competition in banking. Although the presence of a few large dominant banks is not uncommon in a small financial system, competition is important and can be promoted by strengthening the regulatory framework to limit monopoly powers and implementing financial literacy programs aimed at empowering the public with the ability to assess and compare available financial products across banks.
Promote private savings and competition in the deposit base, including through campaigns to bring into the banking system funds currently lying in the huge (partly unbanked) informal sector. This could contribute to widening the deposit base and hence reduce banks’ dependence on a limited number of large depositors with oligopolistic market power.
Deepen the domestic capital markets and help SMEs to obtain financial services. Given the shallow domestic markets and the intrinsic risks of SMEs in a low income country, simply promoting more credit growth is unlikely to help increase the access of credit by the SMEs greatly. The financial literacy programs can assist the SMEs to produce better loan application packages that demonstrate better the viability of their businesses.
Prepared by Felix Fernando Simione and Yuan Xiao.
According to the 2014 FinScope Consumer Survey.
We estimate a co-integration and instrumental variable regression whereby credit concentration is instrumented for by the degree of dollarization in credit and deposit. The estimation controls for the central bank’s lending facility interest rate, reserve money, inflation and reserve requirement. The lending interest rate is the banking system average prime interest rate on loans for one-year maturity. Deposit concentration is measured as the ratio of public companies’ and NBFI’s deposits to total banking system deposits, excluding foreign currency and demand deposits. Credit concentration is measured as credit of the top 5 banks as a share of total banking system credit.
