6/9)WORLD_BANK:POLICIES FOR SUSTAIN

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/* Posted 17 Apr 11:00am 1998 by drunoo@xxxxxxxxxxxx(Dr U Ne Oo) in
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/* -------------" Policies for Economic Reform 6/9 "------------ */

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MYANMAR: POLICIES FOR SUSTAINING ECONOMIC REFORM (6/9)

WORLD BANK Report No. 14062-BA, October 16, 1995.

D. REFORM AGENDA

33. This assessment of the scope and impact of the GOM's reform
program points to the areas in which it needs to be deepened if
sustained and balanced economic growth is to result. More needs to
be done to achieve macroeconomic stabilization by reducing the
fiscal and external imbalances to sustainable levels. The biases
against exports and the continued transfers from the agricultural
sector need to be reversed. And the role of SEs in the economy needs
to be rationalized while the remaining biases against the domestic
private sector are eliminated. This reform agenda is summarized in
Table 1, which also shows the goals and proposed phasing of various
measures.

RESTORING MACROECONOMIC STABILITY

34. WHY ADJUSTING THE EXCHANGE RATE IS CRITICAL. The essential step
in restoring macroeconomic stability is nominal adjustment of the
exchange rate so as to unify it with the parallel rate. Doing this
would help restore external and internal balance. By removing the
tax on the tradeables sector due to overvaluation, it would
encourage the production of exports and import substitutes. Hence,
export growth would accelerate, especially of non-traditional
products, while the strong pent-up demand for imports would fall.
External balance would, therefore, improve.

35. Adjusting the official exchange rate would also held address the
current fiscal difficulties because the recent efforts to compensate
for overvaluation have perversely contributed to the narrowing of
the revenue base. Import-related revenues such as customs duties and
commercial taxes would rise since imports would be valued at a
higher, more realistic exchange rate. Estimates in Chapter 1
indicate that the corresponding revenue increase (excluding the
impact on external debt service) would exceed K50 billion even if
import tariff rates were reduced substantially in conjunction with a
devaluation. Adjusting the exchange rate would also eliminate the
complex set of cross-subsidies in the economy, which currently
deprive many  SEs and government agencies of revenues. The largest
of these impacts would be the eco nomic subsidies that currently
accure to those with access to electricity, petroleum products, and
fertilizers at official prices. The resulting revenue increase (with
full pass through to consumers) is estimated at over K30 billion
(roughly equivalent to current government revenues). Finally, an
exchange rate adjustment would make it easier to improve tax
compliance. At present, the unofficial economy outside the tax net
has grown with the increased importance of the parallel foreign
exchange market, which has blurred the line between legal and
illegal economic activities.

36. If this nominal exchange rate adjustment is to help restore
external balance, it must translate into a substantial real
depreciation of the Kyat, which would require the maintenance of
tight fiscal and monetary policies. To reduce credit demand,
interest rates should also be be raised to positive real levels.
This step would ensure that the allocation of credit to the private
sector is done on an economic basis, while an important source of
subsidies to the SE sector is eliminated. Tightening the fiscal and
monetary stance would also help deal with the fear of policymakers
that a nominal devaluation would worsen inflation. And, the positive
fiscal impacts of a devaluation should allow the authorities to
tighten macroeconomic policies sufficiently to dampen inflationary
pressures. Moreover, such apprehensions are exaggerated since for
much of the population, a significant portion of the price
adjustment has already taken place through the parallel market. The
other fear concerns the increase in the Kyat equivalent of external
debt service. However, this increase is largely nominal, since the
real value of debt service in foreign exchange terms is obviously
unchanged. And, because substantial arrears are already being
accumulated, the situation can improve only with an increase in
export earnings and the negotiation of debt rescheduling, both of
which are more likely with a large devaluation.

37. The continued unwillingness to adjust the exchange rate also
stems from the fear that influential groups in the population would
lose as a result. The main losers would be those who have access to
official imports either directly or indirectly through the resulting
cross-subsidies. Those with direct access to cheap imports include
many SEs, which receive underpriced inputs while exporting little,
as well as groups in the population (mainly government officials and
military personnel) who receive these products through government
shops and rations. The indirect beneficiaries include consumers of
petroleum products and electric power at official prices. While
difficult to estimate precisely what part of the population
currently benefits from these subsidies, it is likely to be only a
small fraction, which is already better-off than the bulk of the
population. Part of the impact of higher prices on groups such as
civil servants, whose real incomes have been eroded over the past
decade, could be offset with higher wages. And, in cases where
subsidies are thought necessary, these should be provided directly
and targeted much more narrowly than is possible , as at present,
through the overvalued exchange rate.

38. Against the short term losses of these groups should be
weighted the gains to the economy from reforming the exchange rate
system. Adjusting the exchange rate would encourage the production
of exports and import-substitutes and employment in these activities
would expand. It would also send a strong signal to foreign
investors about the coherence of the ongoing economic reform
efforts, and therby help boost foreign investment flows,
particularly into export sectors. By helping to reduce the fiscal
deficit and better allocating credit demand, inflationary pressures
could be better controlled. And by contributing to export growth
while controlling import growth, it would reduce the need to
accumulate further external arrears. By restoring the Myanma economy
to a path of sustainable medium-term growth, these reforms, thus,
have the potential to benefit far more people than those who would
lose from its immediate impacts.

39. Too little attention has likewise been focused on the economic
costs of continued inaction, particularly on the exchange rate.
Without an exchange rate adjustment, both inflation and the ability
to service external debt are likely to worsen. INflationary
pressures will continue unabated because, as argued before, no
sustained improvement in the fiscal situation is possible without a
broadening of the revenue base. The longer an exchange rate
adjustment is postponed, the more the ability to raise revenues will
diminish. The financial and operational condition of many SEs will
also continue to worsen as they bear the burdens of the economic
subsidies that are provided to a few consumers through the
overvalued Kyat, which will increase the fiscal burden of the SE
sector. Finally, the current account balance will worsen further
without the elimination of the bias against tradeables due to
overvaluation. Hence, external arrears will continue to increase.

40. The obvious conclusion from this conterfactual is that an
eventual adjustment of the exchange rate is inevitable. Postponing
that adjustment is likely only to delay the resumption of sustained
growth of the Myanma economy, and, therefore, would impose large
economic costs in terms of foregone output. A less costly
alternative would be to acknowledge the pressing need to restore
macroeconomic stability, and assign the central role in this
strategy to an adjustment of the nominal exchange rate. The policy
discussion could then shift, more fruitfully, to the question of how
such an adjustment would be accomplished and, as important, of how
consistent fiscal and monetary policies could be pursued so that
this nominal adjustment translates into a real depreciation.

(7/9) REORIENTING INCENTIVES

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