Policy Review: Cabinet Resolution to Limit Capital Outflows

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By Martin Mwinga In 2005, the Minister of Finance announced that measures will be put in place to limit the outflow of capital (money) from Namibia to other countries, mainly to South Africa. These measures are in the form of a domestic asset requirement that forces pension funds and insurance companies to invest in unlisted companies, and also the measure to force asset managers to reduce their investment in dual-listed companies from 35 percent to 10 percent. In addition the Minister of Finance announced that all government-owned institutions would be forced to invest their surplus funds with banks and not with other institutions such as asset managers or unit trust companies. In December, Cabinet endorsed the Ministry of Finance recommendation and gave the Minister of Finance the green light to begin with their implementation. The recommendation made by the industry seems to have been ignored by the line ministry. A retired army general once said, when you decide to enter a war, you must be prepared to bear the full cost of the war. We all know that the full cost of the war is always borne by ordinary citizens. These policy decisions will have serious repercussions for the financial sector, the savers and the economy. What were the main reasons identified by the Ministry of Finance as the main determinant of capital outflow to South Africa from Namibia? The Ministry of Finance provided no convincing economic reasons for introducing partial capital controls between Namibia and South Africa. The only main reason provided was that capital outflow to South Africa is reducing the availability of capital for lending to the private sector and therefore limits economic growth in Namibia. This is quite misleading and is not a reflection of facts as I will show below. The failure by the Ministry of Finance to undertake proper research and therefore base policy recommendation on facts could lead to wrong policy prescriptions, a mistake committed by many governments. Determinants of capital flow between Namibia and South Africa Without a comprehensive understanding of the determinants of capital flows between Namibia and South Africa, it is difficult to evaluate the effectiveness of policy measures that cabinet has taken. In addition, once we understand the main reason as to why capital flows out of Namibia to South Africa, we will be able to prepare for negative consequences that result from these proposed measures. Empirical evidence shows that low interest rate and macroeconomic instability in the form of high inflation and unmanageable government finances due to high deficits and debts are the main causes of capital outflow. In Namibia however, this does not seem to be the case. Real interest rates are higher than South Africa, the country has enjoyed macroeconomic stability since independence and therefore is not the cause for high capital outflow. What then explains capital outflow from Namibia to South Africa? 1. Historical legal origin of a country, its institutions and policies have a direct impact on the direction of capital flows. Institutional qualities have a first order effect over policies as a determinant of capital flows. Namibia has been a member of the common monetary area (CMA) before and after independence and therefore capital flows should be understood from that context, and that as long as this institutional arrangement (CMA) remains in place, any policy to limit the outflow of capital to South Africa remains futile and will yield no intended results. In fact one of the conditions in the CMA agreement is free capital mobility and the integration of member countries’ financial markets. 2. Diversification reasons: Capital outflow from Namibia to South Africa happens through the high savings of insurance companies and pension funds. Pension fund assets have grown from N$5 billion in 1995 to around N$28 billion in 2005, while insurance companies have grown from N$1.5 billion in 1991 to N$12 billion in 2005. As a result of this growth, these institutions had to operate and comply with certain investment prudential guidelines. In an attempt to comply with these investment mandates, these institutional investors have designed an asset allocation strategy that enhances high returns with minimal risk. As part of their diversification strategy, these institutions have been extending their asset class holding beyond the border of Namibia, by holding shares on the South African stock exchange. One can safely conclude that the main reason for outflow is an attempt by these institutions to diversify their portfolio risks and increase returns for savers. Implications of Cabinet decision While cabinet has the absolute power to impose its decisions and citizens are expected and required to comply, policy of this nature should not be based on political or emotional basis, as their effect will be felt by many generations to come. The proposed policy measures could easily result in banking or financial sector instability, and a financial burden on the state to make up for the shortfall in people’s savings shortfall. Policy challenge 1: The problem in Namibia is not the availability of funds or capital to finance SMEs or projects. That banks are not lending enough to the private sector is misleading the nation. From 1995, total deposits in the banking system amounted to N$3.5 billion and have since increased to N$19 billion by December 2005. Total lending to the private sector in 1995 amounted to N$6.5 billion and increased to N$24 billion by end of 2005. In both 1995 and 2005, commercial banks lending to the private sector exceeded their deposits and to meet this demand for credit banks borrowed from South Africa to close this gap, for example in 2005, banks borrowed more than N$6 billion from South Africa to meet their financing needs. The allegation by the Ministry of Finance that there is only a one-way outflow of capital is therefore not true and not supported by data. The Ministry of Finance either by ignorance or lack of knowledge failed to establish that the reason why most SMEs and previously disadvantaged people cannot access funds from banks is not due to availability of funds, but is due to lack of security or collateral. Collateral is the missing link in the lending equation and it is this issue that the Ministry of Finance should address and come up with schemes that will enable most Namibians to access finance. Policy challenge 2: It is not the business of insurance and pension funds to lend to the real sector of the economy. Their core business is to insure against risk of loss, death and provide for benefits at retirement. Commercial banks are the institutions established to fulfil the lending function. To force insurance companies and pension funds to invest directly to the real sector of the economy demonstrates the lack of understanding of why these institutions exist. When banks or companies are short of funds they can issue a commercial paper or a bond and raise long-term capital from pension funds and insurance companies, and this trend is developing as we have seen a number of companies issuing papers for a longer period. Government through the Ministry of Finance has a responsibility to develop a corporate bond market that will help with issuance of long-term bonds that will satisfy the asset-liability needs of pension and insurance companies. Policy challenge 3: Forcing pension funds and insurance companies to reduce their investments in the South African markets will lead to low returns on savings of ordinary Namibians. Most pension funds will experience shortfall that they will have to cut back on benefits offered to members. The 2000 labour survey by the Ministry of labour shows that 60 percent of Namibia’s population are youth (below the age of 40) and unemployment is concentrated in this category, while the age group from 40 years and above are employed, and this group has a high propensity to save. Putting the pieces together it looks like the part of the population that has a high income and high savings rate in Namibia is in the age group of those towards retirement who are saving for both their retirement and providing for their children. Pension funds and insurance companies are the main form in which they are saving and most of these are the previously disadvantaged group of the population. With the move from defined pension funds where pension benefits are guaranteed by the employer to defined contribution where the risk of poor performance of a pension fund is borne by the member, the decision by cabinet to reduce the amount invested in high performing asset classes in South Africa will lead to low returns and put financial pressure on government finances. Policy challenge 4: The decision to force all government-owned companies/Parastatals to hold their cash surplus with banks only and not with asset managers and unit trust companies is self-defeating and will lead to more capital outflow, contrary to what the government intended to achieve. If billions of dollars are channelled through banks, interest rate will not fall due to excess liquidity in the banking system, but banks will use this excess saving to reduce their foreign liabilities and increase their foreign asset. Since the new proposed measures exclude the banking sector, capital will continue flowing out of Namibia to South Africa, contrary to what the government intended to achieve. The Ministry of Finance must swallow its pride and postpone the implementation of these policy measures until such time as a proper research and inquiry is conducted and finalised. Such policy paper will advise government on how to structure new products (venture capital and private equity funds) that will close the existing gap in our financial sector. We have worked hard to build our savings over the past years and let us put our minds together and implement policies that will have an everlasting benefit to our economy, while we continue building more savings for our future generation.