Tunisia - Financial sector report

Report No. 5263-TUN Tunisia Financial Sector Report December 16,1985 Regional Projects Department Industrial Development and Finance Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY * ,' ''' '' ;' - '' 4:' --' '':'' -' .~~~i X sg vkf} - ~ ~ *it~~. t-C~~~ce225~~), mY ~ ~ ~ Z,r- ,~~~~ ~~~ ,.~~~~~s' k " s e  CURRENCY EQUIVALENT Currency Unit = Tunisian Dinar (TD) 1980 1981 1982 1983 1984 (Nov.) US$ 1 = TD 2.4691 2.0251 1.6929 1.3695 1.2494 TD 1 = t 0.4050 0.4938 0.5907 0.7302 0.8004  FOR OMCIALu USE ONLY List of Abbreviations. AFH Housing Land Bank API Investment Promotion Agency APIA Agricultural Investment Promotion Agency APHANE Program to assist small farmers in the North-East BCMA Banque de la Cooperation du Magreb Arabe BDET Banque du Developpement Economique de Tunisie BFT Banque Franco-Tunisienne BIAT Banque Internationale Arabe de Tunisie BNDA Banque Nationale de Developpement Agricole 3NDT/COFIT Banque Nationale de Developpement Touristique/Compagnie Finan- BNT Banque Nationale de Tunisie ciere du Tourisme BS Banque du Sud BTEI Banque de Tunisie et des Emirates d'Investissements BTKD Banque Tuniso-Koweitienne de Developpement BTQI Banque Tuniso-Qatari d'Investissements CAVIS Old-age, Invalid and Widow Insurance Fund CCP Postal Checking Center CENT National Savings Fund CES Exceptional Solidarity Contribution (20% of TRC) CLCM Local Mutual Credit Funds CNEL National Housing Savings Fund CNRPS National Retirement Fund CNSS National Social Security Fund CPE Personal Income Tax ETAP National Petroleum Company FBCI Credit and Investment Subsidy Fund FNAH National Fund for Housing Improvement FNG National Guarantee Fund FOPRAM/FNPAPM Fonds National de Promotion de l'Artisanat et des Petits Metiers FOPRODI Industrial Decentralisation Promotion Fund FOPROLOS Housing Promotion Fund for Wage Earners FOSDA Special Fund for Agricultural Development FOSEP Special Fund for Fishery INS National Statistics Institute IRVM Securities Income Tax OC Cereal Office ONV Office de Mise en Valeur ONH National Oil Office (Olive Oil) PE Public Enterprise SCMA Agricultural Mutual Cuarantee Companies SICAV Variable-capital Investment Companies SME Small- and Medium-scale Enterprises SMIG National Minimum Wage SNIT National Building Company SPROLS Social Housing Promotion Company STB Societe Tunisienne de Banque STEC Tunisian Electricity and Gas Company STUSID Societe Tuniso-Sgoudienne d'Investissements et de D4veloppement TPS Sales Tax TRC Tax on Interest on Credit Balances TTB Tax on Stock Market Transactions This document bas a resticted distribution and may be used by recients only in the performnce of their offrl duties. Its cutents may not otherwise be dislosed witbout World Dank authorizatioL  Abstract This report analyses the Financial Sector in Tunisia and makes recom- mendations for strengthening policies and institutions to increase domestic resource mobilization and improve investment allocation. It reviews the efficiency of the banking system, the Government's credit policies, the development of the capital market, and the financing of agriculture, industry, housing, and public sector enterprises. The recent downward trend in the domestic savings rate and the high investment rate led to a resource gap, which, if not reduced in the near future, will lead to unsustainable external debt levels. Specific measures to improve savings are recommended. Although Tunisia has a well developed financial system, there are constraints on the autonomy of the institutions involved and on the com- petition among them. Recommendations to address these issues are outlined in Chapter Ill. Chapter IV recommends the introduction of a system of credit controls which would impose greater discipline on the expansion of credit by the banking system. An active interest rate policy would form an integral part of the overall credit policy. The introduction of liberalization measures to improve the efficiency of the financial sector are discussed in Chapter V. Chapters VI to IX give a detailed analysis of the financing of the agricul- tural, industrial, housing and public enterprise sectors.  TABLE OF CONTENTS INTRODUCTION 1 General Background 1 Macro-Economic Aspects 2 Increasing Domestic Savings 3 Stricter Control of Credit 3 Improving the Efficiency of Resource Allocation 3 SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS 6 I. Domestic Financial Resources and Economic Development 6 II. Public Savings Mobilizations 7 III. Household Savings 7 IV. Financial Institutions 10 V. Credit Policy 12 VI. Selective Credit Policies 15 VII. Financing of the Agricultural Sector 16 VIII. Financing of Industry 18 IX. Financing of Housing 20 X. Financing of the Treasury and of Public Enterprises 21 Xi. Capital Market 23 I. DOMESTIC FINANCIAL RESOURCES AND INVESTMENT FINANCING 26 A. The Economic Setting 26 B. Structure of Savings 29 C. Structure of Investment 30 D. Financing of Investment 34 E. MediumrTerm Prospects 37 II. SAVINGS MOBILIZATION 41 A. The Major Components of Domestic Savings 41 B. Public Savings 41 The recent downward trend in public savings 41 The recent trend of receipts 42 The recent trend of expenditure 42 Public savings in coming years 43 C. Household Savings 47 Liquidity of the Tunisian economy 47 Savings in the form of bank deposits 50 The share of demand deposits in the total deposits of the banking system 52  - ii - The influence of institutional deposits on the trend of time deposits 52 Deposits of emigrant workers 53 Special savings accounts and time deposits 53 Borrowing interest rate policy 56 Increase in borrowing rates 57 Measures supplementing the interest rate increases 59 The place of housing savings in the mobilization of household savings 61 Financial instruments offered to savers 63 The policy of the banks with regard to the receiving of deposits 65 III. BANKING SYSTEM INSTITUTIONS 68 A. The Structure of the Tunisian Financial System 68 B. Resources of the Banking Institutions 69 Structure of deposit-bank and investment-bank resources 69 Financial requirements of the development banks in the next few years 70 Raising of resources by development banks on the local market 71 International market resources and government guarantee 74 Exchange-risk coverage for foreign-exchange loans 74 C. Competition, Banking Specialization, and the Creation of New Banks 77 Competition in the banking system 77 Independence of the development banks, and theirrelationships with the public sector 79 Bank intermediation margins 80 Bank specialization 82 Creation of new financial institutions 83 The offshore banks 85 IV. CREDIT POLICY 87 A. Monetary Policy and Overall Credit Policy 87 Growth of total domestic credit 87 Monetary system credit and recent monetary policy 88 Credit by other fianancial establishments 91 B. A New Policy of Control of Growth of Credit 92 Imposition of credit ceilings 92 Increasing of the compulsory reserve ratio 96 Bank refinancing policy 97  - iii - C. Lending Interest Rates Policy 100 Raising of lending rates 100 Interest rate flexibility 102 V. SELECTIVE CREDIT POLICY 104 A. Structure of Contributions from the Financial System to the Economy 104 B. The Existing System of Selective Credit Policies 105 Diversity of selective credit policy objectives and instruments 105 Rediscount policy 105 Prior authorization and rediscounting agreements 106 Differentiation of interest rates 106 Overall ratio of development financing 107 Specialized financial institutions 108 Special-purpose government funds 108 Negative aspects of the selective credit policy 109 C. Toward a New Selective Credit Policy ill Measures to modify the present preferential credit policy ill Kodification of the rediscounting policy ill Adjustment of the average level and range of preferential interest rates 112 Changing the ratio of private mediumr-term credits 113 Kodification of the mechanism for subsidizing preferential credit 114 VI. FINANCING OF THE AGRICULTURE SECTOR 115 A. Investments in Agriculture and their Financing 115 Financing of Agricultural investment 116 B. Agricultural Credit Policy 118 Growth of credit to agriculture 118 Agricultural credit institutions 118 Instruments of agricultural credit policy 122 C. Problems of Agricultural Credit 124 State subsidies 124 Intermediation margins 126 Accumulation of unpaid debts 127 Access to amd rationing of agricultural credit 128 VII. FINANCING OF INDUSTRY 131 Investments in the manufacturing sector 131 Financing of manufacturing enterprises 132 State intervention in credit to industry 134  iE~ ~ ~ ~ ~ ~ ~ ~~~~~i - iv - Export credit 138 Medium- and long-term export credit 141 Export credit insurance 142 Credit for export-oriented investment 142 Equity capital financing 143 Financing of small and medium enterprises (SHEs) 144 VIII. INSTITUTIONAL FINANCING OF HOUSING A. The Housing Finance Institutions 148 B. Housing Finance Instruments 151 Site acquisition 151 Home purchase/construction loans 151 Rental Housing 152 C. Performance of Mortgage Lenders 153 CNEL 153 CNRPS and CNSS 154 FOPROLOS 154 Commercial Banks 155 D. Review of Housing Finance Mechanisms 155 Principal problems 155 Interest subsidies 156 Rental housing investors 157 Site acquisition loans 157 Fragmentation of the housing finance system 158 Rigidity of lending conditions 158 Strategy for a more radical transformation of the housing finance system 160 IX. FINANCING OF THE TREASURY AND THE PUBLIC ENTERPRISES A. Financing of the Central Government Deficit 162 B. Financing of Public Enterprises 164 Introduction 164 Financinal analysis of public enterprises 164 Bank lending to public enterprises 171 Financial flows between the State and the PEs 171 Reform of the public enterprises 172 Budgetary allocations to the public enterprises 173 Rehabilitation of PEs 173 State withdrawal 174  v X. THE CAPITAL MARKET A. Overview 177 B. Structure 178 The Primary market for fixed-yield securities 178 The secondary market for fixed-yield securities 179 The Primary market for variable-yield securities 180 The secondary market for variable-yield securities 180 Brokerage agents 182 C. Development of the Capital Market 182 Introduction 182 Potential for development of the market 183 Suggestions for development of the capital market 184 Expansion of the supply of new securities on the market 184 Tax measures 186 Institutional changes 187 Protection of investors 188 List of Tables Table A.2.1. Tunisian Workers Abroad 189 Table A.2.2. Maximum Interest Rates Payable by Deposit Banks 190 Table A.4.1. Essential Central Bank Interest Rates 191 Table A.4.2. Essential Interest Rates Payable by Deposit Banks 192 Table A.4.3. Monetary Situation; 1979-83 193 Table A.4.4. Central Bank Holdings and Obligations 194 Table A.4.5. Holdings and Obligations of Deposit Banks 1979-83 195 Table A.6.1. Benefits Available to Investments in the Agriculture and Fisheries Sector 196 Table A.7.1. Investments in Manufacturing Industry (1980-1983) 198 Table A.7.2. Distribution of Approved Projects According to Ammount of Investments (new projects only), 1983 199 Table A.7.3. Investments Project Approved by API 200 Table A.7.4. Exports of Manufactures 201 This report is based on the work done by a sectoral mission that visited Tunisia from May 20 to June 8, 1984. The members of the mission were Messrs. J. da Silva Lopes (Chief, Consultant), B. Pottker (Assistant Chief), Mr. Farsad (Economist), C. de Boissieu (Consultant), Buu Hoan (DMF), S. Rothman (IMF) and S. Haddad (IFC). Messrs. J.F. Landeau and J.P. Chausse also assisted with the writing of the report. The report has been updated on the basis of the discussions with the Tunisian authorities in April 1985.  INTRODUCTION General Background 1. This report is an important contribution to the overall economic and sector work program of the Bank currently underway, which includes among others: a review of the Tunisian Five-Year Plan (1982-1986), a report on Industrial Employment, an Industrial Policy Report and several sector studies covering agriculture, housing and transport. It was prepared at the request of the Tunisian Government in order to respond to three major concerns: the domestic resource gap, the adequacy and efficiency of the financial-institutional framework and the effectiveness of existing credit policies for the main economic sectors. 2. Tunisia's economic and financial system is to a considerable extent a managed system, where market forces are allowed to play only a limited role. Prices (including wages and interest rates), investments, imports, foreign exchange and credit are all regulated and controlled by a sometimes heavy bureaucratic machinery. While this system functioned with a reasonable degree of success during the seventies, when foreign exchange resources were relatively abundant, it has functioned less effectively and efficiently in the past three years. Foreign exchange constraints and external disequilibria have in this period accentuated the internal disequilibria created by this excess of controls and regulations. 3. The financial sector is as much regulated as the other sectors of the economy. A multitude of administered interest rates has resulted in a confusing pattern of incentives and disincentives. These rates, the level and structure of which was established at a time when the Government was the largest saver and investor, do not particularly encourage private savings (except for special saving schemes for housing, the setting up of a small business and to encourage deposits of foreign workers); they have lost most of their function of allocating funds to potential investors on the basis of efficiency. Almost all credits to the economy, except credits to the Government, need prior approval by the Central Bank which decides on a case by case basis or are provided on the basis of approval by other Government agencies (API for investments, Ministry of National Economy for imports). The financial institutions, working in a system of fixed margins (which are relatively small in comparison with other countries) cannot afford to take risks and have scaled down their financial services. All these factors have led to a fragmentation of financial markets, created inter-sectoral distortions, with a less than optimal allocation of credit, and favored public over private investments. Finally the Central Bank pursued an extremely accommodating overall credit expansion leading to inflation and balance of payment pressure. 4. While the Tunisian authorities have become aware of the deficiencies of this managed system, they are sensitive to the risks of relaxing controls in an abrupt fashion given the present internal and external economic and  financial disequilibria. They agree that relaxation of controls and a greater reliance on the market mechanisms would enhance the efficiency of the economy. However, they fear that a rapid relaxation of these controls would, in the short run, accentuate the existing imbalances. 5. Against the above background, this report proposes a gradual transition towards a more liberalized system. It recommends a series of coherent actions which would give greater room for the markeL to play its role, would replace A priori authorizations by ex-post controls, would introduce a greater degree of flexibility and would provide more autonomy and responsibility to the financial institutions, all within a clear set of objectives and targets. For some time the financial s7stem would remain a managed one but these recommendations would set the country on the road to further relaxation of controls as and when the increaied efficiency of the economy, particularly in the productive sectors, would improve Tunisia's competitive position and balance of payments. For maximum impact, greater financial liberalization would have to go hand in hand with greater relaxation of price, investment and trade policies. Macro-Economic Aspects 6. The Tunisian economy expanded very rapidly during the Fourth and Fifth Development Plan periods (1972-81), recording average annual GDP growth of 7.5%. During recent years, however, substantial difficulties have begun to appear. GDP growth has fallen to 3.3% during 1982-84. The average inflation rate (measured by the consumer price index) rose from 7.8% in 1976-81 to 10.5% in 1982-1984. The balance of payments deficit has remained high, reaching 10.4% of GDP in 1984, in spite of the slackening of economic growth. 8. The outlook for the coming years is not very favorable. The good performance during the 1970s was explained in large part by the expanded oil production and improved terms of trade consequent on the rise in world oil prices. In contrast, the current projections indicate that volume of oil exports will tend to fall and no substantial improvements are foreseen in Tunisia's terms of trade. The Tunisian authorities therefore face considerable challenges in gradually raising the level of living of the population, absorbing unemployment, reducing the balance of payments current account deficit and bringing inflation under control. 9. Pursuit of these in part conflicting objectives will call for coordinated application of a wide range of economic policy measures. Among these, the proposed reform of the financial system could play an important role. The object of the present report is to study the potential contribution of these changes to improving economic growth and reducing domestic and external disequilibria. Improving economic growth will call for a higher domestic savings rate and more efficient allocation of financiai resources among alternative uses. Reducing domestic and external disequilibria will call for tighter control of total domestic credit. The purposes of the measures for improving the financial system can therefore be grouped into three broad categories: (1) increasing domestic savings; (2) tighter credit control, and (3) more efficient allocation of financial resources.  -3- Increasing domestic savings 1O. During the last few years domestic resources have financed about one-third of investment. The balance of payments deficit was 9.4Z of GDP in 1982, 8.8% in 1983, and 10.4Z in 1984. If the resource gap remains so wide in the years ahead, external debt will rapidly rise to intolerable levels. If the recent downward trend in the domestic savings rate is not halted and even reversed, the Tunisian authorities will be compelled to reduce the investment rate so severely as to have adverse consequences for future economic growth. 11. The difficulties in the way of improving savings are examined in Chapters I and II of the report. Chapter I analyzes the trend of domestic savings structure and the resource gap problem against the general background of recent economic developments. Chapter II examines the problem of improving public saving and possible financial measures to stimulate household saving. It also highlights the need to halt the downward trend of public saving by improving the taxation system and, in particular, stricter control of current budget expenditure. It also recommends a number of measures to stimulate financial savings of households. These include raising the interest rates on savings accounts and time deposits, and changes in compulsory placement ratios and other regulatory requirements imposed on the financial institutions that make time deposits and savings accounts less attractive than demand deposits. Stricter control of credit 12. During the period 1980-83 total domestic credit of the financial system (including the development banks) rose on average by 23% a year while the money supply expanded on average by 18%. Since the velocity of income circulation of money has declined very little, the rapidity of monetary growth has been a factor in inflation and in balance of payments presstirc. There are currently no general target levels for money or credit. Control of the money supply is based essentially on limits on Central Bank refinancing of Lhe development banks. Chapter IV recoumends the introduction of a system of capping of domestic credit as a method of controlling monetary growth. It is felt that such a system would allow the monetary policy authorities to assess more clearly the impact of their credit decisions on the money supply (and consequently on inflation) and on the balance of payments. It would also allow the authorities to tune these decisions more finely. Chapter IV also proposes other changes in overall credit policy, particularly with regard to raising the compulsory reserve ratios, refinancing of the banks, and lending interest rates policy. ImprovinR the efficiency of resource allocation 13. One of the basic functions of the financial sector is to channel the funds it obtains from savers toward the utilizations that will contribute most to the development and equilibrium of the economy. In Tunisia the financial sector is prevented from performing this function with satisfactory efficiency by (i) the very far-reaching official intervention in credit operations; (ii) the very sharp disparities in the operating conditions of the various financial institutions, and (iii) the inadequate development of the capital market.  -4- 14. The authorities intervene in credit operations not only throu1h overall control of money supply volume and general regulation of the financial system but also through the distribution of total credit among the various categories of operations and the specific conditions prescribed for some of them. This intervention is applied through an array of instruments: a very detailed and very complex lending rates grid, with substantial variations between different types of operations; the requirement of prior approval by the Central Bank, which applies to a high proportion of bank loans; compulsory ratios of placement of bank resources in capital equipment bonds issued by the Treasury and in mediumrterm loans; the interest rate subsidies and subsidized loans granted by the various government funds in favor of lending to certain sectors; the assumption by the Government of the exchange risk in loans obtained abroad by certain institutions; the allocation of resources to certain specialized institutions and the particularly favorable loan terms applied by them, and so on. 15. The problems created by all these forms of intervention are examined in Chapters IV through X of this report. Those chapters cover general credit policy, selective credit policies, and the special credit policies followed in the agriculture, industry, export, housing and public enterprise sectors. The government interventions examined in those chapters substantially distort the allocation of financial resources, by fragmenting the market and causing inequalities in the terms of credit access by the various sectors. It is true that official intervention in financial operations can be justified by discrepancies between social prices and costs and market prices and costs. But these discrepancies are very commonly traceable to the effects of government intervention on other sectors of economic activity. 16. It can be concluded from the foregoing comments that improving the resource-allocation efficiency of the financial system calls for the introduction of far-reaching liberalization measures, i.e. a substantial scaling down of government intervention in credit operations. However, sizable financial liberalization would be practicable only as an integral part of a general trend of liberalization of economic activity as a whole. Advancement toward substantial financial liberalization would therefore be difficult inless the authorities took the policy decision to introduce radical changes in the general orientation of economic policy. However, if such a decision could not be taken, it would at least be possible to take a gradual approach, introducing partial changes, with the object of eliminating or reducing some of the major constraints and distortions imposed by government interventions that currently impair the efficiency of the financial system. The recommendations put forward in the present report are geared to this step-by-step approach. The recommendations must therefore be regarded as a first step, to be supplemented by further financial liberalization measures during subsequent stages. 17. Among partial liberalization measures to be taken during the first phase, it is recommended that the authorities abolish the requirement of prior authorization by the Central Bank, which applies to a high proportion of bank loans, and widen the ranges of variation of lending interest rates and bank commissions fixed by the authorities. It is also recommended that, to reduce  the distortions caused by the regulatory measures and interventions not abolished, they should introduce a number of adjustment measures, including the following: greater flexibility in the interest rates set by the authorities; narrowing of the disparities between the more highly and the less highly subsidized interest rates; creating the conditions for more equitable competition in medium-term lending between the deposit banks and the development banks; setting up mechanisms for stricter control of budget expenditure on subsidies to certain types of loans and better coordination between th.e conditions of granting of such loans. The general purpose of these recommendations and others of the same type put forward in the report is to reduce the fragmentation of the financial market, increase competition on that market, improve the conditions of granting of loans, and reduce budget expenditure on subsidized loans. 18. The efficiency of credit resource allocation depends not only on greater financial liberalization and correction of the distortions caused by government intervention and regulation. It depends also on the institutional structure and operational capacity of the financial system. Although Tunisia has a well developed financial system, there are problems with respect to competition among the various types of existing institutions, raising of the necessary resources to fund the operation of the development banks, and creation of new specialized institutions. These problems are examined in Chapter III. Recommendations are offered in that chapter with the object of: Ci) promoting greater competition between the various types of financial institutions; (ii) establishing more equitable conditions of mobilization of resources by the development banks; (iii) the exercise of prudence in the creation of new financial institutions, particularly specialized institutions, which could aggravate the fragmentation of the financial market and raise bank intermediation costs. 19. Finally, an important component of the policy of improvement of the efficiency of the financial system is development of the capital market. In Tunisia, as in most developing countries, the capital market is not very active. Development of this market could help improve the financial structure of the enterprises by enabling them to raise more stable resources. Against this background, Chapter X presents an analysis of the regulatory, institutional and fiscal measures that could stimulate development of the capital market.  -6- SUMMARY OF CONCLUSIONS AND RECOMHMENDATIpNg I. Domestic Financial Resources and Economic Development 1. During the period of the Fifth Economic and Social Development Plan the Tunisian economy underwent rapid expansion based on an improvement in the terms of trade, due mainly to the rise in oil prices. However, average annual GDP growth fell, from 6.3% in 1977-81 to 3.3% in 1982-84, owing to the effects of the drought on agricultural production and the unfavorable trend of the international oil market. During recent years the domestic and external imbalances have worsened severely. The Administration budget deficit reached 6.7% of GDP in 1983 and 7.6Z in 1984. Finally, the sharp pressure of domestic demand pushed inflation to about 9% in 1983 and 1984 in spite of tightened price control. 2. Consumption has increased in real terms faster than GDP in recent years, reducing the domestic savings rate from 24% of GDP in 1980 and 1981 to around 20% in 1983 and 1984. The rate of household saving is estimated to have improved, increasing from 7.8% of GDP in 1981 to 9.2% in 1984, but not sufficiently to offset the declines in government saving, from 9.8Z of GDP in 1981 to 8.6% in 1984, and in public enterprise saving, from 7.0% in 1981 to 2.9% in 1983. 3. The investment rate has remained high, of the order of 30% of GDP, in spite of the unfavorable economic situation in recent years. Because of the decline in savings this has resulted in a shortage of investment resources and necessitated increased recourse to direct foreign investment (which financed about 13% of total capital formation) and foreign loans. As a result, the external debt burden has risen sharply and will exceed 50% of GDP in 1985. 4. In the next few years Tunisia cannot continue to rely on an inflow of foreign resources similar to that of recent years. Moreover, it will not be easy to increase the rate of domestic savings, particularly government savings, to any considerable extent in view of the downward trend of oil receipts. In these circumstances, to avoid a rapid build-up of external debt Tunisia will need to contain the growth of total demand, to stimulate exports of manufactures and to reduce sharply the rate of fixed investment. The Tunisian authorities have already been looking into measures for better controlling capital expenditure. Their goal is to reduce the investment rate to approximately 25% of GDP over the next few years. To alleviate the adverse effect of the reduction in the investment rate on the growth of national product it will have to try to improve the incremental capital/output ratio (ICOR), which rose from 2.7 during the Fourth Plan to around 12 during the last three years of the current Sixth Plan. On the basis of reasonable hypotheses concerning the ICOR, and with real growth rates of 3-4% for GDP and 5-6Z for savings during the second half of the present decade, nearly 70% of investment could be financed by domestic savings six years from now. The external debt burden would then be held at a tolerable level (below 50% of GDP) and the debt service ratio would not be much higher than 20%.  -7- II. Public Savings Mobilization 5. The rate of public saving (excluding the public enterprises), calculated using the methodology of the IMF's Government Financial Statistics (which gives lower rates than the national accounting method but shows the same trend in recent years), has fallen from 9.2% of GDP in 1980 to 4.8% in 1984. This deterioration in public saving is due mainly to the unfavorable trend in expenditure. 6. Oil receipts, which had risen to 6.4% of GDP in 1982, fell back to 5% in 1984. Income and profits taxes have consistently represented a very low percentage of GOP, usually less than 5%. While total budget receipts have increased from 31.4% of GDP in 1980 to 35.5% in 1984, the outlook for the years ahead is not very encouraging: oil receipts are expected to continue to fall arnd Tunisia cannot count on an increase in import duties similar to that of receat years. 7. In spite of the small potential increase in receipts, current expenditure of the Government rose from 22.2% of GDP in 1980 to 30.5% in 1984, as a consequence of particularly sharp rises in wages, public-debt interest and, above all, consurer subsidies and transfers to households and enterprises, which together reached 13% of GDP in 1984 (10% in 1981). 8. With the aim of correcting the trends indicated by the projections and maintaining the level of public savings, the authorities should seek to increase non-oil tax revenue and should step up their efforts to tighten control of the growth of current expenditure. 9. In the fiscal area, substantial gains, particularly in equity and efficiency, will be obtainable through the tax reform, which is aimed at simplifying taxes, lowering certain rates considered to be too high, and progressively widening the scope of the value added tax. The Tunisian authorities have already introduced a number of measures orienced toward these goals. Gradual advances are now being made toward combating tax evasion. The domestic prices of certain oil products, which were below the prices in effect in many other countries, have recently been raised. However, tax revenue requirements could necessitate new increases in those prices in the future. 10. Nevertheless, in view of the already high tax burden -- about 30% of GDP, not counting oil receipts -- the Government's action to avoid a decline in the rate of public saving should focus mainly on control of current expenditure. This control should be directed essentially to wage expenditures and transfers to consumers and public enterprises. The 1985 budget already reflects major efforts to contain expenditures on subsidies and civil servant wages. The recommendations contained in Chapters V and IX concerning interest rate subsidies could help to reduce budget expenditure on current transfers. III. Household Savings 11. About 40% of household savings is placed in financial assets, a very high proportion of which is accounted for by currency and time deposits. The gradual increase in the M2/GDP ratio from 39.8% in 1977 to 43.5% in 1984 consequently gives a good picture of the trend of financial saving. The share  -8- of bank deposits in the total money supply has risen gradually, from 70% in 1967 and 75.6% in 1975 to 78.1X in 1983, which is in line with the normal trend in medium-income countries like Tunisia. 12. The amount of time deposits has declined during recent years, mainly as a result of the fall in deposits of insurance companies and social security funds. The share of time deposits in total deposits of households has also fallen, while the share of special savings accounts has risen substantially, as a consequence of the tax exemption they enjoy, their liquidity and their interest rate (which is quite attractive in comparison with other forms of saving and which in real terms has probably shifted into the slightly positive range, following the recent increases for accounts with a term of longer than two years). 13. A not inconsiderable share of the monetary components of saving consists of deposits by Tunisian workers abroad. The banking system offers such workers foreign exchange savings accounts and convertible dinar accounts that pay interest higher than the special savings accounts and exempt from tax. However, it has to be recognized that the introduction of new savings instruments for Tunisian workers abroad has so far proved to be of limited effectiveness. 14. Lending and borrowing interest rates are closely managed. The general thrust of the proposed interest rate policy is set forth in paragraph 37 below. In April 1985 the Tunisian authorities introduced interest rate increases that were partially in line with the Bank mission's recommendations. However, many of the borrowing rates are still negative in real terms after taxes, despite recent increases. It would be desirable to increase them a little more for placements in excess of six months. To stimulate financial savings by households, consideration should thus be given (except in the highly unlikely case of a rapid and substantial drop in the inflation rate) to the following adjustments to the borrowing rates: Ci) The interest rates on time deposits and certificates of deposit (bons de caisse) with maturities of up to 2 years (whether registered or to bearer) should be increased by 2 points. The real after-tax yield on time deposits of 1 year to 18 months would be about 8.6% and would thus remain slightly positive, assuming that inflation is held at around 8%; (ii) The interest rates on time deposits and certificates at 2 years or longer (which at present account for about one-half of time deposits) should be deregulated; (iii) The interest rates on special savings accounts should be increased by 1.5 points; the spread between the yields of time deposits and special savings accounts at more than 2 years would be narrowed from 1 point to about 0.5 of a point; (iv) The interest rates on demand deposits should be kept at their present levels, i.e. 1% for deposits of enterprises and 2% for those of individuals; (v) The interest rate on convertible dinar deposits of Tunisian workers abroad should remain at the present level of 10.5%;  -9- (vi) The interest rates on savings accounts in foreign exchange should match the interest rates on deposits with similar characteristics and in the same foreign currencies in other countries; they should be changed fairly frequently (for example, every three months) to reflect changes in the interest rates of each currency; (vii) ahe interest rates payable should be made more flexible. To this end, the interest on time deposits and certificates at less than 2 years and on special savings accounts should be tied to a base rate. 15. The proposed increase in borrowing rates should be accompanied by similar increases in bond interest rates. It would help to raise the share of financial savings in total savings and the proportion of household savings mobilized by the financial intermediaries. This would make it possible to reduce the nonproductive direct investment of informal savings (certain real-estate assets or durable goods) and to raise the overall efficiency of investment. Moreover, the rise in interest rates payable would help, at least in part, to slow down capital outflows and to discourage the nonrepatriation of export earnings, which has been taking place in spite of exchange control. 16. Since the resource structure of the deposit banks includes a high proportion of demand deposits, the recommended increases in interest rates payable would cause an increase in average cost which, even after two or three years, would not exceed 1 point. 17. The following action would be necessary to make time deposits and special savings accounts more attractive to the banks: (i) There would be three levels of cash reserves, the increase of which is proposed in paragraph 33: a rate for demand deposits; a second, lower rate for special savings accounts and time deposits of up to 12 months; and a third, even lower rate (which might even be zero) for time deposits and special savings accounts of more than 12 months and deposits of Tunisian workers abroad regardless of term. (ii) The ratio of compulsory placement in capital equipment bonds and CNEL bonds should be differentiated in accordance with a formula similar to that proposed in (i) for the cash reserve ratio; (iii) The ceilings for credit expansion proposed in Chapter III should be determined in light of the growth in the deposits of each bank with different weights assigned to each type of deposit, e.g. 1 for demand deposits and time deposits up to 12 months, 1.5 for time accounts of over 12 months, and 2 for deposits of Tunisian workers abroad. Equity funds would receive a weighting of 3. 18. The authorities have introduced new "financial instruments" and are granting significant tax advantages to stimulate household savings. Three new financial instruments have been introduced since 1982: employment savings accounts, for accumulation of the self-financing required for the execution of small projects; project savings accounts, whose purpose is to build up the funds required to finance projects approved or eligible for assistance by FNPAPM, API or APIA; and investment savings accounts, for the acquisition of  - 10 - securities of approved companies. The introduction of study savings accounts is also contemplated. All these formulas enjoy substantial tax advantages. 19. It is still too early to assess the impact of these new financial instruments. However, it would seen undesirable to go any further in this direction, for three reasons: (i) the proliferation of earmarked savings schemes would fragment the financial system and reduce its efficiency; (ii) it is necessary to limit the cost to the State budget of the tax advantages accorded to earmarked savings accounts; and (iii) the advantages accorded to such accounts frequently accrue largely to individuals with medium and high incomes. The authorities should therefore avoid the proliferation of new savings formulas. They could, however, consider the introduction, after thorough study, of a financial instrument -- to be offered by CENT and, if they were interested, also by the deposit banks -- which would be reserved in principle to individuals with taxable incomes below a certain threshold. 20. The Tunisian banks have shown substantial dynamism in the mobilization of household financial savings in spite of their minimum balance requirements for the opening of deposit accounts. The number of bank offices per capita is higher than in other countries of comparable development, though there are still signs of inadequate bank infrastructure and a high concentration of bank offices in the best-served areas. The current regulations require that any bank program for the opening of five or more branches must provide for at least one outlet in localities that totally lack banking facilities. This requirement should be supplemented by incentives to open offices in the poorly served areas, for example in the form of temporary tax advantages (in particular, accelerated investment depreciation). IV. Financial Institutions 21. Tunisia has a well-developed financial system comprising, in addition to the Central Bank, ten deposit banks, nine development banks, two specialized savings institutions, a network of postal checking offices, six portfolio management agencies, seven offshore banks, a leasing company, offices representing foreign banks and the stock exchange. 22. The development banks are in a distinctly less favorable situation than the deposit banks with respect to the mobilization of resources, since their ability to receive deposits and their use of Central Bank refinancing are closely limited. The resources of the development banks comprise special government loans earmarked for certain specific types of credits, loans obtained abroad, and their own capital. The BDET and, recentlv, STUSID have also obtained resources through the issuance of bonds, though in modest amounts. The new development banks have expanded their operations considerably during recent years by using their own very large capital, but in the future they would need to tap other financial resources. 23. Consideration should be given to the following measures to increase the mobilization of resources for the development banks: (a) Government loans: If the Government gives up responsibility for part of the financing of the public enterprises and if that responsibility is transferred to the development banks, part of the corresponding financial  - 11. - resources, currently used by the State, should also be transferred to them. This would mean that part of the proceeds of the issues of capital equipment bonds (bons d'equipement) the deposit banks are required to subscribe would be transferre directly or indirectly to the development banks. (b) Refinancing by the Central Bank: To ensure more equitable distribution of Central Bank resources between deposit banks and development banks, and to reduce the average cost of the development banks' resources, the authorities should consider establishing better facilities for rediscounting medium-term credits in favor of the development banks. This would not necessarily mean undesirable increases in the money supply if compensatory adjustments were made in other rediscounting categories or in the money market. (c) Issuance of bonds: The absorptive capacity of the Tunisian financial market is limited, but it could be developed if more interesting financial products were offered. The development banks could contribute to the market's development by issuing bonds on terms likely to attract subscribers. (d) Increase in equity capital: If the development banks proved sufficiently profitable in the next few years they could raise equity funds by offering shares for public subscription or seeking additional contributions from foreign partners. 24. The new development banks will undoubtedly be able to obtain foreign loans without needing the Government's guarantee. That guarantee should be given only in cases where the interest rate difference between guaranteed and non-guaranteed loans is very large. It has to be borne in mind that once the first government guarantee has been given for a private international loan, all international creditors will ask for similar guarantees. 25. The system of coverage of exchange risks should be based on payment by the beneficiaries of commissions, which would differ according to the currencies involved in each loan. The cost of the foreign resources would be uniform after payment of these commissions, and the borrowers would have no reason, as they have at present, to prefer loans in strong currencies, with lower interest rates but higher appreciation risks. 26. The average cost of commercial bank resources is considerably lower than that of development bank resources (difference of 3 to 5 percentage points). With the object of establishing more equitable conditions of competition between the deposit banks and the development banks, the present de facto nonregulation of interest rates on long-term credits should be maintained and the recommendation made in paragraph 23 above should be implemented so as to reduce the cost differences between the resources used by development banks and those used by deposit banks to finance medium-term loans, particularly to the SKEs. 27. The intermediation spreads of the Tunisian deposit banks are lower than those found in many developing countries and lower even than those of a number of small and mediumr-sized developed countries. BDET's intermediation costs are also lower than those of the development banks of many other countries. This situation is probably explained by the discipline imposed by the Central Bank and by the regulation of the spreads between lending and  - 12 - borrowing rates. Since the Tunisian market is very small, the comparatively small intermediation spread suggests that economies of scale have not been an important factor in the efficiency of the Tunisian banking system. However, in spite of all the uncertainties it appears that the creation of new banks would not do much to improve the efficiency of the Tunisian banking system. 28. There is some specialization in the Tunisian banking system. While this has advantages, it also involves risks. Experience in Tunisia shows that the specialized institutions are too vulnerable to the difficulties of their specific sectors and consequently often seek to diversify their operations. Moreover, excessive specialization could reduce competition among the banks, to the detriment of investors. In the present context, therefore, increased specialization by banks should be avoided. 29. The number of financial institutions operating in the Tunisian market is already quite high for its small size. Nevertheless, the question is often raised of establishing new ones. The creation of new institutions should be agreed to only in the following cases: (i) the conversion of existing institutions, such as the creation of a National Postal Bank to replace the National Savings Fund (CEN) and the Postal Checking Cente: (CCP) and the conversion of CNEL into a Housing Bank; (ii) the creation of institutions with specialized functions that are lacking in Tunisia, such as leasing companies; and (iii) the creation of institutions that bring in substantial amounts of foreign capital (though in these cases it would be preferable to encourage the promoters to look to acquiring or strengthening one of the existing banks rather than setting up a new bank). The creation should be avoided of a national foreign trade bank, of regional banks and of a bank for workers abroad. The establishment of a bank for local governments should also be rejected. Consideration should however be given to a housing bank to replace the CNEL. 30. There are at present seven foreign banks with agencies or offshore activities in Tunisia but their operations are very limited. Foreign banks have shown considerably less interest over the past few years in establishing offshore banks in Tunisia. To revive their interest, and also for balance of payments reasons and to dynamize Tunisia's banking system, the authorities are thinking of considerably expanding the field of action of the offshore banks in the area of foreign exchange operations. In defining a system offering sufficiently attractive advantages to the offshore banks, and at the same time respecting the conditions of well-balanced competition with the local banks, the authorities are faced with the need to decide very carefully among a number of awkward and difficult choices, as they are indeed well aware. V. Credit Policy 31. Credit expanded in nominal terms at an annual rate of around 22Z in 1980-84. The pressure imposed by the expansionary monetary policy on consumer prices and the balance of payments has been contained in part by a tightening of price controls and of the import licensing system. Such measures may mitigate the internal and external imbalances temporarily, but they cannot provide a lasting cure for these disequilibria. 32. At present the authorities are announcing no explicit overall targets for money and credit. To curb inflation and the balance of payments deficit,  - 13 - it would be well for the authorities to institute a system of credit control, setting annual ceilings for the expansion of credit by each bank. The ceiling would be based on the amount of the bank's resources during the previous year (or six-month period), with higher rates for equicy funds, deposits of Tunisian workers abroad, time deposits and savings accounts than for demand deposits (see para. 17). Some preferential creditS such as seasonal farm loans and short-term export credits could be exemPted from the ceilings. 33. For better management of the monetary base, so that its expansion will be compatible with credit control, the cash reserve requirement (zero at present) should be raised, with a higher percentage for demand deposits than for time deposits and savings accounts (see para. 17). 34. The introduction of credit ceilings would make it possible to eliminate direct regulation of the volume of refinancing by the Central Bank, which is based on a ceiling that can be as high as 17.5% of deposits and is calculated on the total amount refinanced by each bank. By placing a ceiling on a given commercial bank's credit to the economlYs the Central Bank would indirectly be setting a limit on that bank's refinancing requirements. Furthermore, raising the percentage of required cash reserves as proposed in para. 33 would necessitate an increase in refinancing extended by the Central Bank to deposit banks, to enable them to maintain the same level of total credit. 35. With the introduction of credit controls and an increase in the percentage of required cash reserves, the role of refinancing as an instrument for managing the money supply and the overall VOlu'e of credit would become less significant. Rediscounting should be confined to preferential lending, which is by and large the present situation; nonpreferential credits account for only a rather limited quota (about 10%) of the total amount rediscounted. The additional liquidity that the development banks would need to finance nonpreferential lending under their credit ceilings would have to come from the money market. 36. Matching of the total level of credit, as determined under the system of credit ceilings, with the monetary base would be done through the money market. If the volume of transactions on that market were to reach too high a level and remain there, the authorities could consider other adjustment measures: (i) Raising the percentage of required cash reserves in cases of persistent excess liquidity, and lowering the percentage in the opposite cases; (ii) Reducing rediscounts in cases of excess liquidity, by excluding certain types of credit from the category of rediscountable preferential credit, or by lowering the proportion of each credit that can be rediscounted (e.g., from 80% to 60%), or by establishing rediscount ceilings for each bank. The first two of these alternatives would be preferable to the last. 37. The rise in the average cost of resources due to the increase in borrowing rates as proposed in para. 14 should be reflected exactly in lending rates, to avoid a significant narrowing of the interest rate spreads of Tunisian banks. These rates were in fact increased in April 1985, which  - 14 - represented a major step forward toward implementing the recommendations formulated in 1984 by the Bank mission that prepared this report. Additional increases in the lending rates of 0.5 to 1 point might also be necessary to match the increases in the borrowing rates recommended in para. 14. Over the longer run, the interest rate system should be liberalized. In the short term, however, if the authorities were to attempt to control the volume of money supply, the sudden freeing of interest rates might well lead to either agreements among the banks to limit competition or excessive increases in real interest rates, which could cause grave difficulties for industrial enterprises and for the banking system. In cases where credit supply and demand are rigid, slight changes in supply or demand can give rise to large fluctuations in interest rates. Experience in several developing countries that have tried to impose strict controls on money supply shows that interest rates rose excessively. In order to avoid these risks, the deregulation of interest rates should be introduced gradually. In the initial phase, the policy to be followed should be based on the following: (i) raising of the existing level of interest rates; (ii) introduction of greater flexibility in the average level of interest rates; (iii) establishment of wider spreads for permitted variations in certain lending rates; and (iv) deregulation of certain interest rates. 38. With the proposed increase in lending rates the real cost of credit would still be very low. The rise in the total costs of firms would not exceed 0.2%. 39. To alleviate the impact of the rise in interest rates on borrowers, the Tunisian authorities should consider a modest reduction -- from 8.69% to 6% -- in the TPS on interest paid. The resulting decrease in State tax revenue would be small, inasmuch as the taxable base would expand (because of the increase in interest rates and the normal tendency for the volume of credit to rise). Although the TPS is an easy tax to collect, it has adverse effects on investment, financial intermediation and savings. For that reason, it would be preferable to develop other sources of tax revenue. 40. It should be possible for changes in interest rates to be made with greater flexibility than at present. To this end, the adoption might be considered of a system (already used in part) whereby all lending and borrowing rates of interest would be related to a base rate. Under such a system changes in the base rate would automatically result in changes in borrowing and lending interest rates. Adjustments in the level of interest rates to changes in inflation and in other indicators would therefore become easier and more automatic. 41. Furthermore, the range of authorized spreads for lending rates would have to be broadened, from 1 to 1.5 percentage points depending on the type of credit. Likewise, bank commissions would be fixed systematically in the form of spreads (commissions already fixed in that form would have a wider range). The enlargement of authorized spreads would help to strengthen competition among banks through interest rates, and to adjust effective lending rates to the client risk. 42. Interest rates on long-term lending should remain unregulated as at present. It should be possible to adjust them periodically, as is now done  - 15 - for medium-term loans made by deposit banks. Such adjustment of interest rates on long-term loans seem necessary to protect the banks against the risk of excessive losses which could result from a rise in the average cost of their resources. VI. Selective Credit Policies 43. The selective credit policies followed in Tunisia have contributed to the increase in the proportion of medium-term credit allotted to types of financing which, under normal conditions, would not be of sufficient interest to deposit banks (agriculture, small and mediurm-scale enterprise, housing, investment in less developed regions, etc.). Nonetheless, it has certain negative aspects: (i) the system is complicated; (ii) it fragments the financial market and causes a less than optimum allocation of available resources; (iii) it is very costly for the State, which cannot continue to bear the mounting burden it represents for the medium term; (iv) the advantages of selective credit are not distributed equitably among all firms, and often go to the largest and best organized; (v) the policy of selective credit results in excessive disparities between the costs of different types of credit (ranging from 3% to 14%); (vi) the low cost of subsidized credit induces an artificial increase in demand, and this makes it necessary to impose rationing and administrative controls to avoid the diversion of preferential credit to other uses; and (vii) subsidized interest rates discourage infusions of equity capital and foster the adoption of highly capital-intensive production methods. 44. The following measures should be considered to offset the impact of the negative factors just mentioned: (a) Change in rediscounting policy. If the system of credit controls proposed in paras. 32 through 36 is introduced, only preferential credit should be allowed access to rediscounting by the Central Bank at fixed rates. In principle, it would not be necessary to establish rediscount ceilings for selective credits. If, however, the expansion of the monetary base has not been cowmensurate with total credit expansion, it might be necessary to impose restrictions on the total rediscounted amount of selective credits. In such a case lowering the percentage of the amount of each type of rediscountable credit would be preferable to imposing ceilings on certain categories of credit. It would probably suffice to ha-e only two or three rediscount rates: one for export credits, possibly one for seasonal agricultural loans, and another for medium-term loans. Development banks should also be able to rediscount some of their medium-term loans (which might mean that the Central Bank would have to curtail some of its other refinancing operations, so as to keep tight control over expansion of the money supply). (b) Adjustment of the level of preferential interest rates. Ihe difference between the rate with the largest subsidy and the highest nonsubsidized rate should not be more than 7 points. Some preferential rates which are currently 3X or 4% should be raised to at least 7% or 8%. The liquidity problems caused by a rise in nominal rates should be solved through the introduction of grace periods, longer amortization schedules, and even - if necessary - total or partial capitalization of interest for an initial period.  - 16 - (c) Change in the ratio of private medium-term credits. Since the establishment of new development banks the ratio of private medium-term credits required of the commercial banks has become less necessary. It seems preferable to promote the involvement of deposit banks in the financing of investment through incentives rather than through the requirement of a high percentage of mediumrterm credits. This being the case, an initial phase might call for a decrease in the proportion of medium-term private credits from its present 18% to 15%. Also proposed is the gradual introduction, within the ratio of medium term private credits, of a "subratio" of 7% for medium-termn credit to SMEs and to small and mediumrscale farmers, incorporating the existing 2% subratio for credits to artisans and small skilled tradesmen. If lowering the requirement of such credits from 18% to 15% has no negative effect, further reductions could be made in the future. Ultimately one might envisage a ratio of 7%, which would apply solely to credit to SHEs. (d) Modification of the system of subsidies for preferential credit. The system for subsidizing interest rates on preferential credit for capital investment projects should be revised. The recipients of such credit should receive the interest rate subsidies directly from their banks, regardless of whether the loans are rediscounted with the Central Bank. This would forestall the danger of excessive pressure from selective credit on the expansion of the monetary base. All interest subsidies -- including those granted at present by FOPRODI, FOSDA, etc. -- should be distributed by a single agency. With this in mind, a Credit and Investment Subsidy Fund (FBCI - Fonds de Bonification de Credits et d'Investissement) could be set up within the Treasury, financed by appropriations in the State budget. The government agencies with particular responsibility for sectoral policies (API, FOSDA, APIA, FOPRODI, etc.) would give their opinion on the projects to be subsidized or on the criteria for granting them; however, financial management itself would be concentrated in the proposed fund. This course of action would make it possible to: Ci) calculate and control more strictly the cost of the policy of subsidizing interest rates and investments, and (ii) make the interest rate subsidy policy subject to overall criteria rather than to sectoral and partial criteria, which often are not sufficiently coordinated, as is the case at present. The Treasury and the various State funds should not make loans to enterprises, either as reimbursable advances or in any other form. VII. Financing of the Agricultural Sector 45. The Sixth Plan calls for an increase in capital investment in agriculture, which is considered to be a priority sector, from 12.9% of total investment in 1977-81 to 18.9% in 1982-86. Public investment (government and public enterprises) will account for about two-thirds of investment in the sector. Through FOSDA, the State is helping to finance more than two-thirds of private investment, but the role of bank credit in the financing of such investment is expected to become more important in the future. 46. In addition to the adverse effects of selective credit in general, the agricultural credit policy gives rise to a number of specific problems, including the following: (a) The high cost of subsidies. The cost of interest and other subsidies  - 17 - of FOSDA in 1982 can be estimated at some TD 16 million. To this must be added the State's assumption of the risk of nonrepayment of loans guaranteed by it or financed from budget funds, the cost of covering the foreign exchange risk in loans financed by external resources, the subsidy margins in the rediscounting of agricultural credit at a preferential rate by the Central Bank, and the costs of management and nonrepayment of loans made by the Offices de Mise en Valeur. A priority objective of the change in the agricultural credit system should therefore be to reduce its heavy burden on the State budget. (b) The proliferation uf agricultural credit programs. In the last ten years more than 20 credit programs have been launched for farmers. Such a proliferation fragments the agricultural credit market, causes a less than optimum utilization of available resources, increases the number of middlemen, diminishes responsibility and makes it difficult to monitor and manage the various sources of financing. The diversity of existing programs demands a large administrative apparatus, which raises the cost of distribution and moreover is not very effective since small and medium-scale farmers are served less well than large agricultural operations. Consideration should be given to loan terms that are identical regardless of the category of farmer and of the loan financing sources, with the object of eliminating the (extremely difficult) administrative control currently necessitated by the granting of differential subsidies according to farmer categories. Identical loan conditions would, incidentally, constitute a credit subsidy to small farmers. (c) Inadequacy of intermediation spreads. The lack of initiative shown by the financial system in the financing of agriculture is due in large part to the inadequacy of authorized spreads on agricultural Loans in relation to the costs of management and the high risks of such credit. In 1982, BNT's spread for agricultural loans was 1.1% of its total agricultural portfolio; however, it is estimated that the spread would need to be 5.0% in order to cover management costs, allow adequate provision for doubtful debts, and generate a sacisfactory return on equity capital. Unless spreads are increased as indicated, the other commercial banks cannot be expected to show a heightened interest in agricultural lending. (d) Accumulation of arrears. The rate of recovery on BNT's agricultural loans as of the end of 1983 was only 68%. The rate of recovery of loans made from budget funds (FOSDA) or guaranteed by the Government (SCMA) was below 50%. BNT and the Government have already taken action to improve the rate of recovery of farm loans, but the results to date have not been satisfactory. The seriousness of the present situation demands that the Government move decisively and quickly to lower the proportion of arrears in agricultural credit. Loan collection procedures should be made more efficient, more expeditious and less costly; the action to improve the solvency of the SCHAs should be pursued; and a study should be made of the possible extension of the "Privilge General du Tresor" (for which FOSDA, SCMA and integrated project loans are already eligible) to other agricultural lending in order to bypass the extremely slow and complicated legal proceedings. In cases in which the arrears are essentially due to problems caused by the drought, rescheduling would be the appropriate solution, with the arrears being converted into mediumrterm debts. (e) Problems of small and mediumrscale farmers in gaining access to  - 18 - institutional credit. The number of farmers with access to seasonal credit, in cash or in kind, probably does not exceed 60,000, or less than 202 of all Tunisian farmers. The number of farmers who had received medium- and long-term loans at the end of 1983 was about 80,000, i.e. less than 25Z of the total. Institutional credit is used primarily by farmers with medium-size and large holdings. The authorities have adopted some measures to better meet the nezds of small and mediumrscale farmers. These include earmarking part of the proceeds of external borrowings for them, the establishment of some special programs, exclusion of investments made by Large-scale operators from some of the benefits stipulated in the August 1982 Law, and bolstering of the Societes de Caution Mutuelle Agricole (SCMAs). Despite these measures, the agricultural credit rationing currently being applied does not foster the use of credit by small and mediumrscale farmers. Only by eliminating the reasons for credit rationing (large subsidies and incentives to expanded financing of the sector by the financial institutions) can an appreciable improvement in access by these farmers to institutional agricultural credit be brought about. (f) Administrative intervention. A. medium-term objective of the Government should be to reduce the use of budgetary resources for agricultural lending. Agricultura. investments, particularly those of private farmers, should be financed through loans extended by financial institutions which should (i) be fully responsible for loan approval; and (ii) bear the entire associated credit risk. The role of government services, beside the definition of government's agricultural policy, should be to approve highly selective investment subsidies for priority in-estments and to supervise agricultural investments undertaken under development projects or benefiting from government subsidies. VIII. Financing of Industry 47. Manufacturing industry has absorbed a growing proportion of credit from the banking system (deposit and development banks). In recent years, following the establishment of several well-capitalized development banks, their role in the financing of manufacturing companies has expanded considerably. The financing of industrial investment also depends in large measure on participation by the State; this refers not only to public enterprises but to private firms as well. The State acts mainly through the Fonds de Promotion et de Decentralisation Industrielle (FOPRODI), the Fonds de Promotion de l'Artisanat et des Petits Metiers (FOPRAM) and the Fonds National de Garantie (FNG). 48. FOPRODI's role is to support the establishment and expansion of small and medium-scale enterprises (SMEs), through funding for promoters to assist in the capitalization of enterprises, mediumr and long-term loans for capital investment, and assumption, for an initial period of 6 months, of interest on mediumr- and long-term loans from the banking system. The following comments are offered in connection with these benefits: (a) Interest rates on repayable advances, currently 3%, should be raised to 8-1OX. In place of the subsidy based on equity capital, which is due to the sharply negative real interest rates that now prevail, it would be preferable to provide capital investment subsidies determined by specific project characteristics (e.g. employment created, contribution to exports, or value added at international prices).  - 19 - (b) For similar reasons, the highly subsidized interest rate of 4Z allowed on FOPRODI investment loans to SMEs should be increased to at least 10, and FOPRODI's assumption of interest costs for the first six months of medium- and long-term bank loans should be eliminated. 49. FOPRODI also subsidizes interest rates for industrial projects in the less developed regions. The subsidies, which can be as much as 5%, are too high. They should be reduced and the minimum rate paid by the beneficiary should be at least 8%. 50. FOPRAM extends advantages to crafts enterprises and small skilled tradesmen similar to those granted by FOPRODI to SMEs. For the same reasons as Just mentioned in connection with FOPRODI, advances from FOPRAM to finance equity capital should be repaid at interest of 8Z, which would still be a heavily subsidized rate. Action should also be taken to eliminate the assumption of interest during construction on investment loans obtained from banks. 51. The Fonds National de Garantie (FNG) extends guarantees for firms receiving support from FOPRODI and FNPAPM. The guarantee commission payable by the beneficiary to FNG, while subsidized, should not be too low, in order to forestall heavy losses to the State budget and to increase the liability of promoters. At present, the guarantee commission of 118% is paid only once, at the beginning. This commission should be increased and made payable annually. 52. In view of the key role that exports of manufactured goods will have to play in Tunisia's economic development during the years ahead, it is imperative to broaden the benefits of the export credit system: Ca) Procedures for granting short-term prefinancing credit should be more automatic. For instance, it might be stipulated that subsidized prefinancing credits would be for a term of one year, with a normal ceiling of 20% of annual exports (except for exports of capital goods). This would ensure a uniform subsidy rate for all exports. Exporters of goods with a longer production cycle would also obtain nonsubsidized or slightly subsidized prefinancing credit to cover all of their prefinancing requirements. (b) The system for mobilizing claims abroad is satisfactory at present. Any further extension of the term of short-term credits abroad should be avoided, so as not to encourage exporters to hold their funds abroad. (c) There is an urgent need for a system of medium- and long-term export credit, with clearly stated regulations, but there is no need to set up a National Foreign Trade Bank for this purpose. The system can be based on the present deposit and development banks, supported by the Central Bank. The regulations should establish an integrated procedure for prefinancing credit and export credit, and should provide for close coordination with the system of export credit insurance. (d) To supplement the system of export credit insurance -- which has recently been established but which will not cover risks of manufacture borne by the producer or the exporter -- it would be beneficial to allow for the possibility of having FNG cover those risks.  - 20 - (e) The advantages extended to export-oriented investment should be revised (lowering of the minimum percentage of foreign sales entitling firms to benefits; replacement of subsidized interest rates by subsidies based on value added at international prices, in the case of large projects). 53. The following measures should be considered in order to enhance the contribution of the banking system to the financing of small and medium-scale enterprises: - Granting to deposit and investment banks, by the Credit and Investment Subsidy Fund (FBCI) referred to in para. 44 td), of a subsidy of 1X per year on their total medium- and long-term loans to SMEs, to compensate them for the higher financial cost of administering this credit: - Requirement that deposit banks have medium- and long-term loans to SMEs equal to 7% of their deposits. This condition would be introduced gradually and would include loans to artisans and small skilled tradesmen, for which the present proportion of 2% would be eliminated. - Establishment of rediscounting facilities at the Central Bank for mediumr and long-term loans from development banks to SMEs. IX. Financing of Housing 54. The main problems of the housing finance system are: (a) the high cost of subsidies and the resulting distortions; (b) the losses incurred by social security funds in their housing loans and in housing rentais, and the largely inequitable distribution of the benefits they provide; (c) the lack of land on which to build; (d) the fragmentation that results from the multiplicity of institutions involved in housing finance; (e) the rigidity of the terms of most housing loans; (f) the increase in the number of CNEL contracts under which borrowers must wait several years before using the loans to which they are entitled. 55. To reduce the cost of subsidies and correct the distortions that they cause, interest rates on housing loans should be raised to at least 8%, a rate which would still be heavily subsidized. To offset the rise in interest rates the term of loans should be increased to 20 years, and amortization schedules with increasing annual payments should be introduced. Subsidies under the FOPROLOS housing finance program should also be reduced. Interest rates on loans made by that Fund to wage-earners with incomes not exceeding 1.5 times the SMIG should be raised to at least 5.5%; personal loans to workers earning up to 3 times the SMIG should be terminated. 56. The investments of CNRPS and CNSS in rental housing cause those institutions to incur substantial losses and do not fulfill the social purpose of assisting the lowest-income families. In the current rental housing programs, rents should be raised to provide a better return to investors. The rental housing programs of CNRPS and CNSS should be terminated unless the rate of return on these investments can be raised to at least 7X per year. 57. Better financing facilities are needed for the purchase of building sites. To this end, CNEL should broaden the area of application of its  - 21 - housing savings loans. CNEL and the commercial banks should make loans to AFH in order to facilitate the assembling of sites. The commercial banks should be encouraged to make medium-term loans to private developers for the purchase or assembling of sites for residential housing. 58. The following measures are needed to correct the fragmentation that exists in the housing finance system: (a) greater standardization of the conditions of housing loans made by different institutions (interest rates, terms, ceilings, etc.), and (b) better coordination of loans made by different institutions, especially as regards the cumulative amount of loans to a single beneficiary. 59. The following measures are needed to lessen the rigidities of housing finance: (a) periodic adjustments, geared to price increases, of the ceilings on the various types of housing loans (housing savings contracts with CNEL, FOPROLOS loans, loans made by social security institutions); (b) strict observance of the proportion of 5% CNEL bonds required of deposit banks, and use of funds raised thereby to purchase loans already made by CNRPS or CNSS or for the temporary refinancing of housing loans made by commercial banks; (c) broadening of CNEL financing to include nct only the purchase of land but also loans for the renovation and enlargement of existing structures; and (d) development of housing loans of the noncontractual type, financed through the mechanism of voluntary savings and bearing higher and more attractive rates than those of the housing savings system, and by funds borrowed on financial markets. 60. To ensure the long-term success oF CNEL's activities, it will be necessary to overcome the problem of housing savings contracts in which borrowers must wait several years for the loans to which they are entitled because of the lack of land or of houses for sale. To this end, the supply of land and houses will have to be increased and a higher rate of interest paid on housing savings deposits that have reached maturity. In principle, the rate should be equal to that paid on savings deposits at CENT with terms of over two years. 61. The introduction of more radical changes in the housing savings system might call for conversion of CNEL into a housing bank. The resources of the institution will continue to be obtained primarily through housing savings contracts, but other forms of savings would have to be attracted as well. The housing bank could issue bonds when capital market conditions permit. For the long term the possibility of issuing mortgage bonds should also be considered, but at present issues of this type would be premature, given the extent of development of the capital market. X. Financing of the Treasury and the Public Enterprises 62. The financing requirements of the Central Government have grown markedly during the 1980s, from 2.8% of GDP in 1980 to 7.6% in 1984. In 1984 domestic sources financed almost three-fourths of State borrowing requirements, compared to one-fifth in 1980. About two-thirds of domestic financing has been provided by the banking system in the form of required subscriptions of capital equipment bonds by deposit banks. Among other sources of financing the major ones are deposits in postal checking accounts, deposits at CENT, and capital equipment bonds held by CENT.  - 22 - 63. Monetary financing of the consolidated State deficit has increased in recent years, and this has been a factor in the accelerated expansion of the money supply. It is therefore recommended that the Government reduce its use of bank financing not only to curtail the rapid increase in domestic liquidity, but also to avoid (while adhering to the objectives recommended for expansion of the money supply and domestic credit) "crowding out" of the credit needs of the nongovernmental sector. With this in mind, it is proposed that the Government issue development bonds bearing interest rates that will ensure a reasonable return, intended for purchase by households, insurance companies and social security institutions. The fundamental policy objective, however, should be to wean public enterprises away from Government budgetary resources. 64. There are about 300 enterprises in which the State directly or indirectly holds at least 10% of the capital stock, and which are regarded as public enterprises. The operating performance of most has worsened in recent years, and the financial situation of a number of them has become difficult. The public enterprises absorb over one-third of all bank credit. Budgetary allocations in the form of current operating subsidies, capital equipment contributions and subsidies and direct contributions to equity capital have climbed steadily, from 4.5% of GDP in 1981 to 5.9% in 1984. 65. A proposal for reform of the public enterprises was approved by the Council of Ministers on March 24, 1984. The implementation of the reform is to be based on several types of measures: - reduction in budgetary allocations to the public enterprises; - rehabilitation of certain public enterprises; - withdrawal of the State from enterprises in which its involvement is not essential. 66. The reduction, and eventual elimination, of budgetary allocations to the public enterprises should be based on: - the overall productivity objectives established under program contracts between the State and autonomous enterprises; - the raising of prices of goods and services supplied by public enterprises, which have been kept too low; - strict control of subsidies to compensate enterprises providing public services, which must charge unprofitable rates or prices or which are compelled to bear excessive costs for social or political reasons (labor costs in particular); these subsidies will have to be sized in the light of the stringent public finance situation. - replacement of capital equipment financing for the enterprises by the Treasury by loans obtained directly by the enterprises from commercial banks, development banks and suppliers, or -- in the medium term -- by debenture issues on the financial market. 67. The authorities have already included an appropriation of TD 145 million in the 1984 State budget to finance the rehabilitation of enterprises. In addition, the Government is relying on the financial  - 23 - institutions for additional support of its corrective measures, particularly through the conversion of some bank overdrafts to long-term debt, or of some long-term loans to shares. 68. The Government has already announced its intention to withdraw from the number of public enterprises that compete with other firms (i.e., excluding those responsible for providing public services, and natural monopolies), and to increase their management independence. In the initial phase the transfers would be made chiefly to development banks. The withdrawal will have to be gradual, mainly because of the limitations on the necessary resources that need to be mobilized by the development banks and in the capital market, and because it may be necessary to rehabilitate some public enterprises that would be candidates for withdrawal. The basic policy objective to be considered is whether there would be economic advantages in privatizing certain public enterprises. 69. The transfer of financial control of public enterprises from the State to the development banks will generally speaking have to be supported by reorganization programs aimed at improving management and operation which in many cases can be carried out only with additional investments. Eligibility for financing by the development banks should be limited to public enterprises that can become financially profitable and technically viable and can be managed on a commercial basis (without subsidies from or direct control by the State). If the Government finds that these criteria cannot be met by certain enterprises, it would be preferable to keep them under its control until substantive solutions can be found for improving their financial status. In particular, it may be necessary to liquidate some of those enterprises to avoid the heavy budgetary expenditures that they represent. Withdrawal of the State from the financing of public enterprises should make it possible to transfer to the development banks some of the financial resources that the Treasury is now obtaining from capital equipment bond issues and using to fund public enterprises. XI. Capital Market 70. The capital market in Tunisia is not very well developed and is heavily dominated by the State and by institutional investors. The securities traded are limited basically to: (i) capital equipment bonds issued by the State at 5.5% interest and placed mainly through compulsory subscription by banks, insurance companies and social security institutions; (ii) compulsory borrowings, mainly by BDET and more recently by STUSID, bearing interest rates that are in general higher than those paid on capital equipment bonds and on time deposits (taking account of the tax advantages), about two-thirds being subscribed voluntarily by companies and private investors; and (iii) shares, a large proportion of which has been issued in recent years by banks and tourism companies. The volume of transactions on the secondary market is small. 71. Development of the capital market could help to expand and diversify the medium- and long-term financial resources available for Tunisia's economic development, strengthen the financial structure of many firms, make shareholding more democratic, heighten competition within the banking system, and diversify the supply of financial instruments, which should have a favorable impact on private financial savings. The potential for development  - 24 - of the capital market is considerable, especially if (i) the Government implements its already announced policy of transferring some State equity holdings in public enterprises to private ownership; (ii) the development banks turn over their share portfolio as they intend to do; (iii) the development banks seek additional resources by issuing debentures for public subscription; and (iv) the country continues to attract substantial amounts of foreign capital, particularly from the Middle East. 72. Measures to develop the capital market can be grouped into four categories: (a) Improvement of the supply of shares and bonds available on the market: (i) The State should offer on the stock exchange larger quantities of shares of those companies controlled by it that are candidates for privatization. Part of the shares could be sold even if the authorities considered it necessary to maintain the State's majority holding in the capital of certain public enterprises. To prevent a slump in prices, sales should take place gradually, and it might be necessary to involve the financial institutions in the selling process. The subscription of shares offered by private individuals should be encouraged by the formation of Variable-capital Investment Companies (SICAVs); (ii) The development banks should continue to issue bonds that directly tap private savings. Several types of bonds should be considered: fixed-rate bonds; adjustable-interest bonds (which could have amortization periods longer than those for fixed-rate bonds, since they would be less risky both for the issuer and for the subscriber); zero-coupon bonds (like those issued by STUSID); bonds convertible into shares, etc. (iii) If issues of bonds by development banks are successful, similar issues should be offered by nonfinancial public enterprises and by private companies whose financial position is sound. These issues may rpquire a ;tate guarantee during the initial development of the capital market. (b) Tax measures: (i) The tax incencives for investors in securities require that purchasers hold the securities in their portfolio for five years to be eligible for exemption from the tax on securities income; it would be advisable to make this condition more flexible by allowing sales after three years, for example, although with tax advantages lower than those granted after five years; (ii) Withholding at source of the IRVM on dividends places share investments at a disadvantage vis-a-vis bank deposits. It is therefore essential, for the sake of more balanced competition between shares and bank deposits, to reduce the IRVM rate to that of the income tax on time deposits, and to provide for withholding of the latter tax at the source;  - 25 - (iii) The development of the securities market could be fostered by means of tax advantages for companies listed permanently, provided that those companies are subjected to stricter auditing procedures. To encourage the acceptance of the auditing and advertising requirements that would have to be imposed on listed companies, it might be possible to effect a slight increase (e.g. 1Z) in the tax rate on profits of companies that are eligible for listing on the exchange but are not listed, and to lower (e.g. by 4Z) of the tax rate on profits of listed companies. In addition, the tax on stock market transactions (TTB) should be lowered from 0.8% to 0.4% for transactions on the official market (permanent listing). (c) Institutional changes: (i) The formation of variable-capital investment companies (SICAVs), already provided for in the law, should be encouraged through tax advantages, particularly elimination of the risks of double taxation; (ii) The role of insurance companies in the capital market should be enhanced by: (1) eliminating or reducing the legal requirement of subscription of capital equipment bonds by these companies, and (2) improving their financial position and profitability, especially in the field of automobile insurance; (iii) It would be well to encourage the establishment, as stockbrokers, of individuals or companies specializing in the financial market, so as to increase competition with the banks, which noW handle all securities market intermediation transactions. Cd) Protection of investors: Ci) To extend the advantage enjoyed at present by shareholders having privileged information, companies listed on the stock exchange should be obliged to publish a balance sheet and income statement at the end of every six months. It would also be worthwhile to set up a securities market commission with responsibility for: (1) verifying the accuracy of published information and seeing to its correction if necessary, and (2) approving the financial documents that must accompany all public offerings of new shares or bonds; (ii) The bylaws of the Stock Exchange envisaged in Law 69-13 of February 23, 1969 should be drawn up and published. Among other provisions, they should include the regulation of relationships between subscribers and issuers, and the position of bonds with respect to shares; (iii) Stockbrokers should not be legally permitted to engage in the buying and selling of securities of their own or their parent co%pany, in order to avoid conflicts of interest and risks of manipulation with harm to investors.  - 26 - Chapter I DOMESTIC FINANCIAL RESOURCES AND INVESTMENT FINANCING A. The Economic Setting 1.01 Tunisia's economic situation during the last decade was characterized by relatively rapid economic growth along with a favorable domestic and foreign financial position. During the 1970s the economy benefited from substantial terms of trade gains due to the relative increase in oil prices. Petroleum sector revenue not only provided an appreciable addition to domestic savings; it also boosted investment activity and thereby contributed to the growth of output, consumption and imports. The balance of payments and public finances situations, which had deteriorated appreciably by the beginning of the Fifth Plan (1977-81), improved during the Sixth Plan period (Table 1.1). The budgetary and external deficits were easily financed, thanks to the inflow of direct foreign investment and of loans, the oil price increases of 1979-80, and improved economic management during the Fifth Plan period. 1.02 Recently, the economy has experienced a slowdown, due to the shortfall in agricultural output and the decline in oil export prices. During the first two years of the Sixth Plan (1982-86), Tunisia's budgetary and balance of payments positions deteriorated seriously, owing mainly to the sharp rise in wages, the increase in subsidies and budgetary transfers, and the growth of the trade deficit. Although the deterioration, measured in relation to CDP, is not as severe as it was at the start of the previous Plan (1977), it is nevertheless cause for concern since its pace has been relatively fast. Moreover, contrary to previous years, the contribution of the petroleum sector to the economy is declining and it is unlikely that future oil price movements will restore the favorable financial position that Tunisia enjoyed during the last decade. 1.03 GDP, which had stagnated in 1982, mainly because of the drought, rose by 4.7Z in 1983 and 5.5% in 1984. With this recovery the growth of the economy in the first three years of the Plan averaged 3.3%, well below the 5.4% average growth envisaged for that period. In contrast to production, demand continued to expand fairly strongly in 1982-84. Investment, though constant in real terms, exceeded 30% of GDP, compared to the Plan's average target of 27%. This high investment rate is more striking when compared to the number of jobs created, which fell short of the target by about 13%. At the same time, consumption growth, triggered in large part by the wage increases of the last two years, surpassed GDP growth, thus reducing the savings rate from nearly 24% of GDP in 1981 to about and 20% in 1984. The strong demand pressure is reflected in the inflation rate. The cost of living index rose by 13.6% in 1982, but inflation fell to about 9% in 1983 and 1984 following the tightening of price controls. 1.04 Together with the widening savings gap, the balance of payments current account deficit has also deteriorated in the last two years, owing mainly to the fall in net petroleum earnings and the increase in imports.  - 27 - Thus, the current account deficit rose from 7.61 of GDP in 1981 to 9.4% in 1982 (Table 1.1). Following the tightening of import controls in 1983, the current account deficit declined to about 7.5% of GDP, but it rose again in 1984, to 10.4%. The deterioration in the current account position has led to a faster accumulation of external debt. In contrast to its policy in the past, Tunisia has had to turn to foreign financial markets. External public debt rose from 38X of GDP in 1981 to 49% in 1984. Debt service also rose rapidly, reflecting the appreciation of the US dollar relative to the major European currencies. Debt service rose from 14.6% of the value of current receipts in 1981 to over 20% in 1984. The growth of public expenditure accelerated in 1982-83, as a result mainly of the increases in the government wage bill, subsidies and other current transfers and the speedup in public-sector investment. The combination of increased expenditure and stagnating oil receipts led to a substantial worsening of the Administration budgetary deficit, to 6.7% of GDP in 1983 and 7.6% in 1984. 1.05 It is estimated that the growth rate of the Tunisian economy will dip to about 3.5% in 1985, in real terms, mainly as a result of a deceleration in the growth of the country's agricultural product, which in 1983 started out at low levels, being seriously affected by the drought of the previous years. Domestic savings could reach about 20% of GDP. Gross fixed investment is projected to fall by 3.3% in real terns. Consequently, the domestic resource gap should fall from 9.5% of GDP in 1984 to 8.6% in 1985. In the budgetary and fiscal area, the consolidated budget of all of the Administration sector would increase by 7.6% of GDP in 1984 to 8.8% in 1985. This increase reflects to a large extent the growth in current expenditures and also a substantial reduction in capital receipts (which in 1983 were inflated by revaluation of the assets of the Central Bank). With regard to the balance of paymencs, the current account deficit should slightly improve in relation to GDP, but it is nevertheless projected at around 9.6% of GDP. The country's total debt is estimated to exceed 53% of GDP by the end of 1985.  - 28 - Table 1.1 Macro-economic Characteristics Annual Growth Rates (Z) Share of GDP (Z) (Constant Prices) (Current Mharket Prices) IV Plan V Plan VI Plan 1972-76 1977-81 1982-84 1977 1981 1984 GDP, EXPENDITURES AND SAVINGS GDP 8.8 6.3 3.4 100.0 100.0 100.0 Expenditures Consumption 9.6 7.6 4.6 80.1 76.1 79.7 Gross Investment 14.1 9.1 0.1 30.2 32.3 29.8 Exports GNFS 5.6 8.0 0.4 29.5 41.4 34.0 Imports GNFS 13.1 12.1 0.9 39.8 49.8 43.5 Savings Domestic Savings 2.9 2.5 -1.1 19.9 23.9 20.3 National Savings 2.9 3.6 -2.5 19.0 24.7 21.2 As percent of GDP 1972 1977 1981 1982 1983 1984 Consolidated Government Budget Revenue & Grants 25.0 29.9 32.1 34.2 34.5 35.4 Current Expenditure 19.0 21.9 21.9 26.4 27.5 30.6 Capital Expenditure 4.1 12.1 12.7 12.9 12.5 12.5 Deficit -1.0 -6.0 -2.5 -5.1 -5.5 -7.7 Balance of Payments Trade balance -5.2 -15.6 -13.7 -15.4 -13.4 -15.3 Service balance 3.0 4.6 5.2 4.9 4.7 4.3 Transfers 0.5 - 0.9 1.1 1.3 0.4 Current Account Deficit -1.7 -11.0 -7.6 -9.4 -7.5 -10.4 Source: Ministry of Planning  - 29 - B. Structure of Savings 1.06 The rapid growth of output and income in Tunisia has been accompanied by a faster growth of consumption than of GDP, resulting in a steady deterioration in the savings position. As a result, annual growth of domestic savings has declined from 2.9% during the Fourth Plan to 2.5% during the Fifth Plan and -1.3% in the first three years of the Sixth Plan. Thus, the share of domestic savings in GDP, about 24% at the end of the Fifth Plan, fell steadily in the first two years of the Sixth Plan and is projected at 20.8% of GDP in 1985. 1.07 The deteriorating savings performance has been fairly pronounced in the case of the Administration sector, which accounts for over 40% of total savings and includes the central government, the local authorities, the social security system and special funds. The marginal savings performance of the Administration sector has dropped from nearly 33% of current revenue in the Fifth Plan to around 14% in the last three years. Thus, Administration saving, which increased as a share of GDP in the late 1970s, has been declining steadily since 1980, falling from about 11.3% of GDP that year to 8.6% in 1984. The marginal savings propensity of the enterprise and household sectors has also declined, though more slowly. The combined marginal savings rate of these two sectors, close to 20% during 1977-81, has dropped to about 13% in 1982-84. I/ 1.08 It should be noted that Tunisia's national accounts do not break down savings between private and public enterprises. In fact, household and Administration savings are estimated directly and the savings of the enterprises (private and public together) are determined residually. 2/ However, a sample of 50 of the largest public enterprises, operating in nine different sectors, indicates that the savings of these enterprises, which on average account for 3% of GDP, increased in current terms by over 9% a year 1/ Gross savings are related to income in each sector. However, because of the insufficiency of official data on separate household and enterprise income, the combined income of these two sectors has been taken to be the difference between Administration income and gross national income. 2/ These estimates, especially in the case of Administration savings, differ from those obtained from the consolidated financial operations of the central government, which are calculated using the IM?1 method from the Government Financial Statistics (GFS). The differences derive essentially from: the statistical coverage, particularly for the social security system; the treatment of repayment of military loans; and the exclusion of local authorities from the GFS methodology. There are also differences in the treatment of transfers. For examplE, in 1984 about TD 90 million of profits of the Central Bank from re-evaluation gains in 1983 was transferred to public enterprises to offset their foreign exchange losses on debt service payments. The official statistics treat this amount as capital transfers, whereas the GFS statistics treat it as current expenditure.  - 30 - between 1979 and 1983. 1/ However, the bulk of the resources were generated by the few oil-sector enterprises. Leaving out enterprises, the savings performance of the other enterprises shows a declining trend over this period. This is due in part to the very large wage increases of 1982-83 and price control, particularly in 1983. 1.09 Household savings 2/ have remained at between 8 and 9% of GDP since 1980 (Table 1.3). 3/ The share of financial savings 2/ in total household savings rose from about 30% in 1980 to 45Z in 1983 and is estimated to have risen again in 1984. The increase in the share of household financial savings was concurrent with the rise in interest rates in 1981 and in wages in 1982-83. It also took place at a time when restrictions on imports were being tightened, which suggests a possible inertia of consumption rather than an increased savings effort. C. Structure of Investment 1.10 The ratio of investment to GDP is high in the Tunisian economy. Following a substantial increase in investment growth, particularly during the Fourth and Fifth Plans, the share of investment rose from about 20% of GDP at the beginning of the Fourth Plan to about 30% by the end of that Plan in 1976, and since then has fluctuat-. around that level. The most important factors contributing to this high level of investment have been: (a) the low interest rates and the reductions in or exemptions from import duties on capital goods; (b) the ready availability of financial resources following the oil price booms of the middle and late 1970s and the increased production of other mineral resources such as phosphates; (c) the laws of 1972 and 1981 which offered incentives to investment in manufacturing, and (d) the favorable climate for foreign investment, which accounted for about 7.5% total investment in the early 1970s and over 12% in the early 1980s. 1.11 The high level of investment contributed to an impressive growth of output in the last decade. Growth of output reached 8.8% during the Fourth Plan and 6.3% during the Fifth Plan (Table 1.1). Nevertheless, despite the high growth of output and investment, productivity of investment remained low. The incremental capital/output ratio (ICOR) doubled in the last decade, from 2.7 during the Fourth Plan to 5.5 during the Fifth Plan, reflecting in part the concentration on highly capital-intensive projects. The ratio has worsened further in the first three years of the current Sixth Plan, to around 8.8, and without an effort to increase productivity will remain high during the remaining years of this Plan. The level of investment per job created has also remained high. The main goal of the present Plan has been to devote 1/ Savings are calculated as profits minus taxes plus depreciation minus operating subsidies. 2/ Household savings are defined as the sum of financial savings plus self-financing in housing and construction, excluding transfer payments. 3/ This is also consistent with the statistics published in a study on household saving for the years 1979-82 by the Bach Hamba Institute of Quantitative Economics. According to this study, the marginal saving performance of the household sector increased significantly during 1981-82.  - 31 - Table 1.2 Saving, Investment & Financing of Resource Gap (Millions of current dinars) Est. 1977 1981 1982 1983 1984 GDP (Market Prices) 4162 4842 5485 6173 Net Factor Income 19 36 56 35 30 GNP (Market Prices) 2182 4198 4898 5520 6203 Consumption 1764 3169 3780 4360 4923 Domestic Savings 437 993 1062 1125 1250 National Savings 418 1029 1118 1160 1280 Investment 663 1345 1560 1610 1780 Changes in Stocks (-3) (55) (20) (-15) (30) Resource Gap -226 -352 -498 -485 -530 Financing 226 352 498 485 530 Net Transfers - 36 56 35 30 Grants 20 10 11 15 15 Net Direct Foreign Invest. 40 181 238 165 180 Net MLT loans 269 136 186 280 285 Others 1/ -103 -11 7 -10 20 Source: Ministry of Planning 1/ Includes short-term capital movements, change in foreign assets, And errors and omissions.  - 32 - Table 1.3 Investment and Saving (As percent of GDP) Est. Total Economy 1977 1980 1981 1982 1983 1984 Investment 1/ 30.6 28.3 30.9 31.9 29.7 28.3 Domestic Savings 20.5 24.0 23.9 21.9 20.5 20.2 Resource Gap -10.1 -4.3 -7.0 -10.0 -9.2 -8.1 Administration 2/ Investment 5.6 4.6 5.1 5.3 5.4 4.9 Savings 7.0 11.3 9.8 9.3 9.0 8.4 Gap 1.4 6.6 4.7 4.0 3.6 3.5 Enterprises in"estment 20.5 18.8 21.5 22.4 20.0 19.4 Savings 7.6 6.8 7.4 5.9 4.3 5.0 Gap -12.9 -12.0 -14.1 -16.5 -15.7 -14.4 Households Investment 4.5 4.9 4.3 4.2 4.3 4.0 Savings 5.9 5.9 6.7 6.7 7.2 6.8 Gap 1.4 1.0 2.4 2.5 2.9 2.7 Source: Ministry of Planning 1/ Excludes changes in stocks. 2/ Includes central government, local authorities, social security system, and operations of special funds.  - 33 - Table 1.4 Investment and Savings, 1977-1984 (Millions of Dinars) Est. Total Economy 1977 1980 1981 1982 1983 1984 Gross Investment 1/ 670 1039 1345 1560 1610 1780 Current Account Deficit 244 168 316 442 450 500 National Savings 426 871 1029 1118 1160 1280 Net Transfers 23 22 36 56 35 30 Gross Domestic Savings 449 849 993 1062 1125 1250 Administration Investment 123 164 214 257 295 305 Savings 153 399 409 450 494 520 Gap 30 235 195 193 199 215 Enterprises Investment 447 664 898 1082 1095 1195 Savings 166 242 307 288 237 311 Gap -281 -422 -591 -794 -858 -884 Households Investment 100 174 178 201 235 250 Savings 130 208 277 324 394 419 Gap 30 34 99 123 159 169 Source: Ministry of Planning 1/ Includes changes in stocks -2 37 55 20 -15 30  - 34 - the bulk of investment to employment creation. Nevertheless, the number of jobs created during the years 1982-84 fell short of the projected total by around 50,000. The level of unemployment has thus remained high. Despite the fact that over 28% of investment under the Plan has been allocated to highly labor-intensive industries, only 22% of investment was used for these industries in the first two years of the Plan. Moreover, total investment per job has risen by 26%, from an average of TD 23,000 during the last plan period to about TD 38,900 during 1982-84, 1/ against a projection of only TD 25,500 for that period. 1.12 The major share of investment during the last two plans has been concentrated in the industry, housing and transportation sectors, which together accounted foi- over half of investment in the last decade. Similarly, during the last two plans, the share of government and public enterprises in the total investment effort was 56% and that of private enterprises and households 44%. These shares have remained unchanged during the current Plan so far, in spite of the intention to raise the share of private investment. Public enterprise involvement in investment activities has been largest in the extractive industries, transportation and manufacturing. The public enterprises' share in total investment has risen steadily since 1980, reflecting the capital-intensiveness of their investment efforts. Thus, the public enterprises' contribution to total enterprise investment, about one-half in 1980, will rise to an estimated two-thirds in 1983. Similarly, their share in total investment, 35% in 1980, is expected to rise to 41% this year. D. Financing of Investment 1.13 During the Fourth Plan period (1972-76), domestic savings sufficed on average to finance about 78% of investment. This proportion fell to 75% during the Fifth Plan (1977-81) and to 70% during the first three years of the Sixth Plan (1982-84). As a result, the savings/investment gap widened from 6% of GDP in the Fourth Plan to 7% in the Fifth Plan and 10.2% in the first three years of the Sixth Plan. The major reason for the relatively small and stable resource gap during the earlier periods was that capital expenditure, which had risen rapidly during the Fourth Plan period, leveled off to some extent in subsequent years. Moreover, the terms of trade improved significantly, owing to the sharp rise in crude-oil export prices in the early 1970s. The rapid worsening of the domestic resource gap in the last two years conflicts with the Plan's target of maintaining the gap at around 6.7% of GDP on average. 1.14 The resource gap has been financed through a continuous increase in the inflow of foreign resources, with investment the major component (Table 1.2). The bulk of foreign investment has gone to the petroleum industry (about 70% in the last three years) and the rest to offshore industries, direct investment in tourism, and development banks. Foreign investment, which averaged about 18% of the resource gap at the beginning of the Fifth Plan, had increased its share to more than one-half by the end of the Plan period and, on average, financed nearly one-third of the resource gap and 1/ The Mid-Term Plan Review Report of 1984 and the April 1985 Investment Control Report furnish detailed analyses of investment during the Sixth Plan.  - 35 - about 8% of total investment. The establishment of new development banks in 1982 provided an additional channel for foreign investment. Since then, foreign investment has risen to about 40% of the resource gap and about 13% of total investment. The balance of the resource gap has been covered mainly by mediumr and long-term foreign loans (Table 1.2). Overall, the share of external resources in total investment has risen from an average of 21% during the Fifth Plan to about one-third in the first three years of the Sixth Plan. In addition, grants and transfers have covered about 3-4% of total investment. 1.15 The increase in the share of external resources in investment is due to the inadequacy of the domestic saving efforts, in varying degrees, of households, enterprises and government, as indicated in Section B. Analysis of investment financing by these various agents is complicated by several factors: (a) there are various financial flows between the "overnment and the public enLerprises; (b) these flows not only finance investmevt but also cover operating costs, and (c) different results are obtained depending on whether these flows are treated from the national accounts standpoint or from that of the consolidated financial operations of the Central Government. 1.16 According to the national accounts estimates, the administration and household sectors show a savir-s/investment surplus 11 which is transferred to the enterprise sector, consisting of both public and private enterprises (Table 1.13). In the case of the public enterprises, the transfers from the State budget are the principal domestic source of investment funds. These transfers take the form mainly of equipment subsidies, capital participations and loans. Between 1981 and 1983 equipment subsidies financed over 29% of the public enterprises' total investment requirements and accounted for over 72% of the total financial support by the Government to these institutions (Tables 1.5 and 1.6). Altogether, the Government's financial support has covered about 38% of the enterprises' investment needs since 1981. Another equally important source of public enterprise investment financing has been foreign loans which, on average, covered about 37% of their capital requirements in the same period. The rest was financed by bank credit and own sources. 1.17 If, on the other hand, the above-mentioned transfers from the Government are treated as part of Treasury operations and of central government capital expenditure, as shown in the statement of consolidated financial operations of the central government, the government sector also has a resource deficit. 2/ In this case, central government savings, which financed about two-thirds of government investment in the Fifth Plan, sufficed to finance only about one-half over the 1982-84 period. Thus, the volume of resources required to finance the government deficit has risen from about 4% of government investment during the Fifth Plan to 30% since 1982 (Table 1.7). 3/ 1/ Household investment comprises chiefly investments in housing. Administration investment comprises direct investment from the budget (Title II) adjusted for purchase of land, military expenditures, and investment by local authorities, the social security system and the Rural Development Program. 2/ This treatment conforms to that used by the IMF (GFS methodology). See the section on Public Savings in Chapter II. 3/ This is consistent with the increase in domestic borrowing by the central government as shown in the consolidated budget figures.  - 36 - Table 1.5 Financial Flows from Government to Public Enterprises (Millions of Dinars) Est. 1977 1981 1982 1983 1984 1. Equipment subsidies 61.6 146.3 162.6 197.7 218.6 2. Capital participation 28.6 4.6 17.7 16.8 80.2 3. Loans 26.6 33.9 25.1 18.9 6.7 4. Operating subsidies 11.3 21.2 20.3 28.2 15.5 Total 128.1 206.0 225.7 261.6 321.0 Source: Ministry of Planning Table 1.6 Investment Financing in Public Enterprises (Millions of Dinars) Est. 1977 1981 1982 1983 11984 Transfers from government 1/ 116.8 184.8 205.4 233.4 305.5 Foreign loans 104.3 182.5 251.0 220.0 250.0 Bank credit and own financing 84.9 94.5 151.8 215.5 171.0 Total investment 306.0 461.8 608.2 668.9 726.5 Source: Ministry of Planning 1/ Includes equipment subsidies, capital participation and loans.  - 37 - Table 1.7 Investment Financing and Consolidated Financial Accounts of the Central Government (Percentage) Total Economy Government 1977-81 1982-84 1977-81 1982-84 Savings 75.3 69.2 67.8 50.0 Net Transfers from Abroad 3.0 3.1 3.0 0.8 Net External Borrowing & Inv. 21.2 27.7 25.1 19.1 Net Domestic Transfer - - 4.1 30.1 Total Investment 100.0 100.0 100.0 100.0 (million dinars) (4666) (4961) (1976) (2080) Sour-e: IMF, Government Financial Statistics and Staff Reports. E. Mediunr-Term Prospects V1 1.18 Tunisia's savings rate has been one of the highest among the middle-income oil-exporting countries. It will therefore not be easy to raise this rate. Nevertheless, given the size of its financial requirements and the downward trend of oil receipts, Tunisia cannot continue to rely on an inflow of foreign resources to finance investment of a level similar to that of recent years. Maintaining domestic savings at a high level is therefore a vital concern of economic policy. In assessing the prospects for financing a larger share of investment from domestic savings it is important to evaluate the mediumr-term prospects for the economy in light of the oil rituation and of the external debt build-up required to finance the balance of payments current account deficit. 1.19 In the short term, as mentioned earlier, growth should be more rapid than during the early years of the Sixth Plan. Output is estimated to grow, in real terms, by 3.5% in 1985 and to sustain a probable growth momentum of around 4% in 1986 (Table 1.8). Gross investment is projected to fall slightly in real terms in 1985. Furthermore, the World Bank's Plan Review Report recommends leveling-off and even reduction of this gross investment (in order to avoid pressure Gn imports), combining it with improvement of the overall productivity of existing investments. In view of the difficulty in controlling consumption growth, the domestic savings rate is expected to rise only marginally. The current account deficit is not expected to improve substantially in 1985 and 1986 in view of the steady fall in net oil exports. Over the next two years, therefore, it could remain over 10X of GDP, unless 1/ The projections presented in this section are preliminary and may be altered in light of alternative scenarios put forward by the Kid-Term Plan Review Mission.  - 38 - the policies of control of domestic demand are strengthened, as the Plan Report recomends. Financing a current account deficit of this magnitude would be very difficult and would lead to a further increase in the external debt, which already exceeds 50% of GDP. To avoid a rapid build-up of foreign debt and major economic strains in the medium run, policies aimed at controlling the growth of total domestic demand and reducing the external deficit must receive zop priority. 1.20 The longer-term growth prospects of the Tunisian economy depend in part on developments in the oil sector and in part on an appreciable improvement in investment productivity and maintenance of competitiveness on external markets. The Plan Review Report examines the prospects and the necessary policies for accomplishment of these goals. 1.21 The combination of unfavorable terms of trade and budgetary imbalances will undoubtedly affect the level of national savings and will particularly limit public-sector savings as receipts from oil exports decline. In the medium term, the outlook for the economy will depend essentially on the success of the policy designed to maintain national savings at a high level in order to reduce the external resource gap and maintain a low level of foreign debt. The investment rate will probably decrease. 1.22 Maintaining a high rate of saving will call for considerable savings efforts on the part of the central government, public and private enterprises and households. Given the low level of self-financing by public enterprises, priority will have to be given to measures to improve the raising of domestic resources. At the same time, in view of the already high tax burden in Tunisia, the efforts to increase government savings will have to focus on improving public-sector resource management and containing the growth of current expenditure. Finally, the large volume of household savings potentially available makes it important to ensure that they are mobilized and used efficiently. 1/ 1.23 Even if the efforts to improve resource mobilization are successful, the past high level of i'Lvestment cannot be sustained except at the cost of excessive dependence on foreign resources and a sharp rise in debt service payments. The authorities have already started to take steps to reduce the investment rate. The April 1985 report of the National Investment Control Commission (Commission Nationale de Nattrise d'Investissement) recognizes that it will be impossible to keep the investment rate at around 30X as in recent years. One of the goals of this report is to bring the investment rate down to more moderate levels, averaging on the order of 25% over the next few years, so as to alleviate pressure on the balance of payments (35% of investments are directly imported) and to reduce the strain on the public finances (an average of 30% of investments are financed by the budget). To control investment, the authorities are considering introducing the following measures: (i) granting of more advantages for capital expenditure on renewal, maintenance and expansion than for investments designed to finance new 1/ Specific measures to increase public and private sector saving are discussed in the following chapters.  - 39 - ventures; this new approach will make it possible to improve the expected effects of a given level of capital expenditure on output, employment and the balance of payments; (ii) review of advantages granted to nonpriority sectors and projects, in particular building, trade and transportation; (iii) re-wording of the various investment codes to strengthen selectivity in favor of priority projects and to replace the many advantages granted those projects (fixed-rate registration, exemption for imports of capital goods, exemption from the tax on profits, etc.) through a subsidy graduated on the basis of simple criteria (employment cost, effect on the balance of payments, geographic location) granted in the form of a tax credit; (iv) improvement of facilities and incentives in favor of investment by SMEs in the industrial sector, in particular by making acceptance and approval facilities more flexible, by strengthening API assistance to the promoters of such investment, and by awarding credit advantages; (v) partial replacement of the enterprises' contributions to the social security system by a tax, to ensure greater control over labor costs; a possible alternative would be the introduction of a tax on output or on profits, to take the place of part of the wage-based social tax (prdlevement social); (vi) application of stricter criteria governing the choice, appraisal and monitoring of public investment. 1.24 The medium-term projections beyond the Sixth Plan (Table 1.8) suggest that Tunisia needs to control domestic demand and imports and to have a lower growth rate in order to hold the resource gap at around 7-8% of GDP and limit external capital requirements and foreign debt to acceptable levels. The present level of Tunisia's debt is less cause for concern than its recent increase. l/ Continuation of this trend will lead to debt-service difficulties in the future. The projections also assume that while imports will grow more slowly (GDP elasticity of 1.0), the decline in the oil share of exports should be largely offset by the faster growth of exports of manufactures, notably textiles, chemicals and food products but also non-traditional industrial products. The favorable export hypothesis (15% in volume) assum,es that the competitive edge of Tunisia's exports, based on its competitive labor cost, will be maintained in Western Europe (which accounts for about 70Z of its market). It is assumed also that the Government will speed up implementation of the measures to reduce consumption and demand for imports, which was a major goal of the Sixth Plan. With a slower growth of consumption and a faster expansion of exports, a large share of investment could be financed by domestic savings. 1.25 The estimates indicate that with 5.3Z real growth of savings during the second half of this decade, close to 70X of investment could be financed 11 Compared with the other medium-incore countries, Tunisia's economy has a high export percentage. Consequently, while its external debt service rate is lower, its debt/GDP rate is appreciably higher.  - 40 - by domestic savings in 1991. By then, external borrowing commitments and capital account would stand at reasonable levels, allowing the annual debt-service ratio to be maintained at 20% on average. This would constitute an important rate in view ot the dwindling oil export receipts, whi.h were the mainspring of the high level of savings in the 1970s. If the resource mobilization efforts failed to provide additional savings and domestic savings fell short, a larger inflow of foreign resources would be necessary. However, heavier external borrowing would not be tolerable in view of the existing high level of external debt and the severe debt-service burden on the balance of payments. So long as the main imbalance between saving and investment lies in the public sector it will be difficult to ease the strain on overall domestic resources. Serious efforts will be needed to finance a larger proportion of investment through additional savings in the public sector, especially the public enterprises. Table 1.8 Average Annual Growth (Constant 1980 Prices) VI Plan 1/ VII Plan 1/ 1982-84 1985-86 1987-91 GDP 3.4 4.0 3.0 a 4.U Expenditures Consumption 4.6 4.7 3.0 a 4.0 Gross Investment 0.1 5.1 0.6 A 1.3 Exports of GNFs 0.4 3.6 5.0 k 6.0 Imports of GNPs 0.9 5.6 3.0 a 3.7 Savings Domestic Savings -1.1 0.6 5.3 A 6.3 National Savings -2.5 -0.3 4.4 A 5.7 Source: Mid-term Plan Review Report. 1/ These estimates reflect relatively modest growth scenarios consequent on the contraints resulting from the institution of economic structural adjustment policies and from the need to hold Tunisia's external debt below 50% of GDP.  - 41 - Chapter II SAVINGS MOBILIZATION A. The Major Components of Domestic Savings 2.01 It was mentioned in Chapter I that between 1981 and 1984 the rate of national savings in relation to GDP fell from 23.8% to 20.3% as a consequence of the decline in savings of the public sector (from 9.3% to 8.6% of GDP) and of the enterprises (from 7.0X to 2.9% of GDP) and in spite of the increase in household savings (from 7.8Z to 9.2% of GDP). It was also mentioned that, in view of the need to reduce the deficit on balance of payments current account and slow the rate of growth of external debt, the downward trend of the savings rate in recent years must be reversed or at least halted in order to avoid substantial reductions in investment rates. Achieving this goal will call for measures in relation to government, enterprise and household savings. 2.02 Comments an government savings are presented in Section B of this chapter and analyses of household savings mobilization in the following sections. The probiems of enterprise savings are equally important but are not examined in the present report except, incompletely, for the public enterprises (see Chapter IX). 2.03 Increasing enterprise savings depends at the macro-economic level on the rate of growth of GDP, price and wages policy, world prices, the exchange rate, fiscal policy, and so on. At the individual enterprise level, in view of low allround productivity, increased savings also depend on efforts to improve management and introduce more effective production methods. The impact of financial policy on enterprise savings is uncertain. Raising interest rates could discourage recourse to credit and increase self-financing but could also reduce profits and thereby the rate of self-financing. Moreover, the development of the capital market and the improvement of the efficiency of the credit system will make self-financing less necessary and could therefore contribute to reducing enterprise savings. It must be stressed, however, that if reduced self-financing results from the development of the capital markets and of credit there will in principle be an improvement in the efficiency of utilization of financial resources. 2.04 The possibilities for rapid improvement in enterprise savings are small since the recent overall trend shows a contraction of profits and, therefore, of self-financing capacity. According to the most recent data furnished by the Survey of Industrial Activities (Recensement des Activites Industrielles) carried out by the National Statistics Institute, gross oper_ting profits of the industrial enterprises as a proportion of total value added fell from 57% in 1980 to 47% in 1981. B. Public Savings The recent downward trend in public savings 2.05 As explained in footnote 1 to paragraph 1.8, there are two methods of evaluating administration savings: one based on the national accounts and  - 42 - another based on the IMF method applied to Treasury financial statistics. The public savings rates estimated by the second method are lower than those of the national accounts but they show the same declining trend since the beginning of the 1980s. Estimates using the second method put public savings in 1984 at only 4.8% of GNP, against 9.2% in 1980, and at only 38.5% of public capital expenditure, against 72.7Z in 1980. The decline in savings is due to the unfavorable development of receipts and expenditures: whereas current receipts have increased only slightly (from the equivalent of 31.4% of GNP to 35.32), current expenditures have risen rapidly, frcm 22.2Z to 30.5% of GNP. The recent trend of receipts 2.06 On the receipts side, oil revenues, which reached a record level in 1982, subsequently declined as a consequence of the substantial weakening of demand and of a fall in net receipts from oil exports, reflecting lower world prices and the leveling-off of local production. According to the preliminary estimates, oil receipts accounted for 14.1% of current receipts and 5% of GNP in 1984, against 19% and 6.4%, respectively, in 1982 (Table 2.1). Moreover, during the period 1980-84, income and profits taxes consistently accounted for a very low percentage of GNP (generally under 5%). The taxes on goods and services also fell as a percentage of GNP. 2.07 The only notable increase in receipts concerns import duties, the revenue from which is estimated at 28.8% of GNP in 1984, against 23.8% in 1980. This increase is attributable largely to the upward adjustment of import duties. The recent trend of expenditure 2.08 On the expenditure side, the 1980s were characterized by particularly sharp increases in the government wage bill, interest charges on debt, and subsidies and other current transfers. The government wage bill almost doubled during the period 1981-84, mainly as a consequence of sharp rises in the number of government employees and in the salaries and wages scale in 1982-83 (Table 2.3). Debt interest nearly tripled during the period 1981-84, partly as a consequence of the depreciation of the Tunisian dinar in relation to the US dollar. 2.09 However, the major factors in the increase in current expenditures have been subsidies and other current transfers, which have tripled since 1980 and which accounted for around half of the increase in current expenditures during the period 1981-84. According to the estimates, in 1984 subsidies and other current trans'ers became the major component of current expenditure, representing over 40% of such expenditure, i.e. 13% of GNP. The consumer subsidies relate essentially to grain products, although they apply also to other products (for example, fertilizer, sugar, olive oil, milk and meat). Transfers to households consist mainly of the services provided by the various social security funds. The sharp increases that have taken place since 1982 are due to the expansion of retirement expenditures and to the extension of social security coverage to all wage-earners in the modern sector. Current transfers to the non financial public enterprises were relatively small until the end of 1983, but according to the estimates rose substantially in 1984. However, a large part of this growth (TD 90 million) is to be regarded as exceptional in nature: exceptional profits made by the Central Bank of  - 43 - Tunisia through exchange rate gains in 1983, transferred (via a new special consolidation fund) to the public enterprises to offset the exchange losses they suffered through debt service payments. Public savings in coming years 2.10 The outlook for the years ahead is overshadowed by the unfavorable forecast for fiscal revenue from oil production and from imports. Oil receipts are currently projected to decline further; these projections are based on prevailing world market prices and the expectation of a continuing decline in Tunisia's net exportable surplus. In addition, import receipts should rise less rapidly than in the past if, as expected, imports grow more slowly than GNP and if customs duties are not increased. 2.11 In order to correct the trends indicated by the projections and to maintain the level of public savings, the Tunisian authorities need to step up their efforts to improve the collection of non-oil tax revenue. However, in view of the already high level of the ratio between fiscal revenue and GNP, thz efforts should be directed mainly at tighter control of the growth of current expenditure. 2.12 In spite of the constraints resulting from the high tax burden, substantial positive results can still be achieved through the tax reform that has already been initiated. This reform seeks to improve the equity and efficiency of the system by simplifying taxes rather than by raising the tax burden. In the case of direct taxes, in addition to widening the tax base, the reform seeks to standardize the tax system through progressive restructuring while lowering the tax rates for individuals (from 35Z to 25%) and for companies (from 46Z to 40%). In the case of indirect taxes the reform will progressively widen the application of the value added tax so that it can replace certain direct taxes which have already been reduced by several percentage points. The average rates applicab'e at the present time are 44Z for individuals and 29% for companies. In addition, the value added tax has been extended to public works and other construction projects, the transportation of goods, and certain wholesale commerce operations. The taxes on foreign trade should also be modified to rationalize the effective degree of protection afforded local producers. 2.13 Additional improvements could be achieved by strengthening the measures to combat tax evasion. The increase in the domestic prices of certain oil products can also make a substantial contribution to increasing tax revenues. One of the goals of the Sixth Development Plan (1982-86) is to equalize the domestic and world prices of those products between now and 1986. In 1984, average domestic prices, including taxes, were equivalent to only around 90X of the corresponding world prices, but in early 1985 the authorities increased them by an average of 12%, which will increase tax revenues by approximately TD 30 - 50 million a year. 2.14 However, in view of the already high tax burden - about 30X of GDP, not counting oil receipts -- the Government's efforts to avoid a decline in the rate of public saving should focus on control of recurrent expenditures. This control should be directed mainly to wage expenditures and transfers to consumers and public enterprises. The 1985 budget reveals significant efforts by the Tunisian authorities in this direction. The increase in budgeted  -44 - Table 2.1 TUNISIA - Consolidated Financial Operations of the Central Government 1/. 1980-84 (millions of dinars) 1980 1981 1982 1983 1984 Prelim. Budget Figures Total Receipts and Donations 1,131.2 1,334.6 1,655.7 1,890.1 2,187.6 Current Receipts 1,108.5 1,315.1 1,646.4 1,883.4 2,187.5 Car,ital Receipts 0.5 0.8 0.9 1.1 0.5 Dcnations 22.0 5.4 8.4 6.6 0.6 Ac justment -- 13.3 -- -1.0 -1.0 Total Expenditures 1,230.1 1,440.1 1,903.9 2,193.3 2,660.9 Current Expenditures 784.1 909.9 1,280.2 1,507.4 1,891.1 Capital Expenditures 446.0 530.2 623.7 685.9 769.8 Current Savings 324.4 405.2 366.2 376.0 296.4 overall Deficit (-) -98.9 -105.5 -248.2 -303.2 -473.3 Financing 98.9 105.5 248.2 303.2 473.3 External (net) 80.4 108.7 176.0 74.9 146.4 Domestic (net) 18.5 -3.2 72.2 228.3 326.9 Ratios (Z of GDP) Total Receipts and Donations 32.0 32.0 33.8 34.2 35.3 of which: Current Receipts (31.4) (31.5) (33.6) (34.1) (35.3) Total Expenditures 34.8 34.5 38.9 39.7 42.9 Current Expenditures (22.2) (21.8) (26.2) (27.3) (30.5) Capital Expenditures (12.6) (12.7) (12.7) (12.4) (12.4) Current Savings 9.2 9.7 7.5 6.8 4.8 Overall Deficit (-) -2.8 -2.5 -5.1 -5.5 -7.6 Current Savings/ Capital Expenditure 72.7 76.4 58.7 54.8 38.5 Source: Data furnished by the Tunisian authorities. 1/ Includes all Treasury account transactions, off-budget expenditures financed by external aid, and social security operations.  - 45 - Table 2.2 TUNISIA - Consolidatied Current Receipts of the Central Government 1/, 1980-84 (millions of tinars) 1980 1981 1982 1983 1984 Prelim. Budget figures Income and profits taxes 162.2 203.0 242.8 251.8 280.3 Social security contributions 102.9 117.3 146.9 178.6 194.5 Land taxes 25.9 26.2 34.2 38.1 40.1 Taxes or g%vds and services 264.5 310.6 345.0 405.2 442.2 Turnover taxes (56.3) (67.4) (80.5) (122.0) (133.3) Consumption duties (79.9) (116.4) (126.8) (147.2) (183.6) Taxes on provision of services (35.4) (38.5) (52.1) (65.9) (62.6) Fiscal monopolies (52.4) (50.1) (43.7) (16.7) (--) Consumer taxes (40.5) (38.2) (41.9) (53.4) (62.7) Taxes on foreign trade and international transactions 273.3 329.6 450.2 579.2 642.7 Import duties (263.6) (316.8) (438.7) (568.1) (630.1) Export duties (9.7) (12.8) (11.5) (11.1) (12.6) Land revenue 214.4 291.6 363.4 372.2 512.2 Oil receipts 2/ (173.4) (225.9) (312.6) (308.7) (309.3) Miscellaneous (41.0) (65.7) (50.8) (63.5) (202.9) Other current receipts 65.3 36.8 63.9 58.3 75.5 Total current receipts 1,108.5 1,315.1 1,646.4 1,883.4 2,187.5 Ratios (Z) Income and profits tax/ current rece,pts 14.6 15.4 14.7 13.4 12.8 Income and profits taxes/GNP & o 4.9 5.0 4.6 4.5 Taxes on goods and services/ current receipts 23.9 23.6 21.0 21.5 20.2 Taxes on goods and services/GNP 7.5 7.5 7.0 7.3 7.1 Import duties/current receipts 23.8 24.1 26.6 30.2 28.8 Import duties/GNP 7.5 7.6 9.0 10.3 10.2 Oil receipts 2//current receipts 15.6 17.2 19.0 16.4 14.1 Oil receipts 2IIGNP 4.9 5.4 6.4 5.6 5.0 Source: Data furnished by the Tunisian authorities. 1/ Includes receipts on all Treasury accounts plus social security receipts. Z1 Production taxes charged on the profits of ETAP (the national oil company), royalty payments and supplemental surtaxes.  - 46 - Table 2.3 TUNISIA- Economic Classification of the Consolidated Current Expenditure of the Central Government 11, 1980-84 (Millions of dinars) 1980 1981 1982 1983 1984 Prelim. Budget figures Salaries and wages 326.0 410.7 503.0 597.6 646.2 Goods and other services 145.3 132.8 197.2 236.0 267.5 Interest on debt 50.4 64.7 98.1 116.8 144.1 Subsidies and otber transfers 264.4 431.2 490.6 540.7 813.0 Consumer subsidies ( ) (142.6) (160.0) (145.0) (246.0) Transfers to non-financial Public enterprises ( ) (13.1) (31.4) (35.0) (145.0) Transfers to households (.) (150.3) (158.6) (214.3) (265.3) Others (.) (125.2) (140.6) (146.4) (156.7) Others 2/ -5.0 -129.5 -8.7 16.3 20.3 Total current expenditures 784.1 909.9 1,280.2 1,507.4 1,891.1 Ratios (X) Salaries and wages/ current expenditure 41.6 45.1 39.3 39.6 34.2 Salaries and wages/GNP 9.2 9.8 10.3 10.8 10.4 Subsidies and other transfers/ current expenditure 34.1 47.4 38.3 35.9 43.0 Subsidies and other transfers/ GUP 7.6 10.3 10.0 9.8 13.1 Source; Data furnished by the Tunisian authorities. 1/ Includes all expenditures on Treasury accounts, off-budget expenditures financed by external aid, and social security expenditures. 2/ Includes unclassified expenditures and also adjustments for differences between commitments and disbursements.  - 47 - current expenditures is only around 12% against 21.6% in 1984. In particular, subsidies on consumer goods and to the public enterprises are projected to increase only by 152 against 43% in 1984. The recommendations contained in Chapters V and IX concerning interest rate subsidies and the public enterprises could help to reduce budget expenditures on current transfers. C. Household Savings 2.15 As mentioned in Chapter I, household savings rose from 7.8% of GDP in 1981 to 9.2% in 1984. To be able to interpret this recent rise in household savings propensity, we need to have a fairly precise function of household consumption. Failing such a function we have to be content with qualitative observations. It is necessary to distinguish two aspects of household savings: their amount and their structure. The level of household savings appears, in Tunisia as in most other countries, to conform largely to the Keynesian model since it is largely governed by the evolution of real income. Thus, the recent increase in the global savings and financial savings of households is attributable in large part to the increase in real wages. 2.16 The level of saving is also influenced by other factors: interest rate levels, labor market prospects, and so on. Interest rates appear to have a greater effect on the structure than on the level of private savings. Recent experience confirms the impact of interest rate variations on the share of financial savings in total household savings and on the fraction of private savings mobilized by the financial institutions. Thus, the high rate of growth of time deposits and savings deposits in 1981 (23%, against 14% in 1980 and 10% in 1982) must be compared with the rise in the interest rates scale that took place in April 1981. Liquidity of the Tunisian economy 2.17 About 40% of household savings is placed in financial assets, of which currency and bank deposits account for a very high proportion. The trend of financial savings of households is consequently closely bound up with the liquidity of the Tunisian economy. 2.18 From 1978 to 1981 nominal GDP grew at more or less the same rate as the monetary aggregates Ml and M2, leaving the liquidity rates (Ml) and (M2) (GDP) (GDP) more or less constant. This trend was broken in the 1982-83, when the monetary aggregates Ml and M2 grew faster than nominal GDP (i.e. the trerd of income-velocity of Ml and M2 was downward). In 1984, the income-velocity of Ml accelerated somewhat and even that of M2 increased slightly. Table 2.4 RATE OF LIQUIDITY OF THE ECONOMY (end-of-period monetary aggregates) 1977 1978 1979 1980 1981 1982 1983 1984 Ml GDP 26.2 27.7 26.7 27.1 27.0 28.7 30.3 28.3 M2 GDP 39.8 42.2 41.5 41.2 41.7 42.7 44.0 43.5  - 48 - 2.19 Interpreting liquidity rates in an economy in which prices are closely controlled by the public authorities is a difficult task. In terms this context, price control can lead to overvaluing of the liquidity rate of the economy or, what comes to the same thing, undervaluing the income velocity of the currency. Comparison of the various liquidity rate figures over the course of time is meaningful only if the degree of price management by the public authorities remains approximately constant. 2.20 The recent changes in the liquidity rate of the Tunisian economy justify the introduction of a credit ceiling policy (Chapter III) by means of which it can be better controlled. Thus, for example, even if the increase in the liquidity rate does not necessarily entail an imediate acceleration of inflation, it can pave the way for a rise in inflation during subsequent periods consequent on activation by the economic agents of monetary cash balances built up previously. 2.21 On the scale of a partial international comparison, still by no means easy to interpret since concrete delimitation of monetary aggregates and degree of price control can vary from one economy to another, tne Tunisian economy is not particularly "liquid." Table 2.5 compares the liquidity rates of certain Mediterranean countries of Africa with those of certain countries of southern Europe. Table 2.5 COMPARISON OF LIQUIDITY RATES, 1982 ml M2 GDP GDP Tunisia 0.29 0.43 Morocco 0.36 0.44 Greece 0.18 0.71 Spain 0.26 0.84 Portugal 0.30 1.08 Italy 0.47 0.79 Source: Data taken from International Financial Statistics, IMF. 2.22 Analysis of the liquidity rate of the Tunisian economy needs to be supplemented by study of the trend of real cash balances. From 1980 to 1983 real cash balances increased beca we the money supply (M2) rose appreciably faster than the retail price index or the GDP deflator. Table 2.6 TREND OF REAL CASH BALANCES 1980 1981 1982 1983 1984 Rate of growth of M2 18.6% 19.3% 18.9% 18.5% 11.7% Rate of growth of GDP deflator 14.5% 11.4% 16.8% 8.4% 7.8% Rate of growth of retail price index 10.0% 9.0% 13.6% 9.0% 8.4%  - 49 - 2.23 Except in 1983 and 1984, the growth of real cash balances is less sharp when it is evaluated using the GDP deflator, less directly controlled by the public authorities than the retail price index (the cost of living index used to adjust the guaranteed minimum wage). It would a fortiori be reduced if it were referred to an index of inflation in Tunisia that eliminated the effect of price control. It is nevertheless quite clear that there has been a rise in real cash balances. This development can no doubt be linked to the high growth rates of GDP volume in recent years. 2.24 The share of currency in the money supply (M2) furnishes interesting information on the degree of financial development of the Tunisian economy. As in other countries, this share is declining but it is subject to fluctuations which result both from changes in the policy concerning lending interest rates (the ratio falls significantly in 1981 after the rise in interest rates on time deposits and special savings accounts) and from the decrease in time deposits (as in 1982). Table 2.7 SHARE OF FIDUCIARY MONEY IN M2 (END OF YEAR) 1967 1975 1976 1977 1978 1979 1980 1981 1982 1983 29.9% 24.4% 24.0% 24.4% 23.8Z 21.7% 20.7% 19.9% 21.4% 21.9% 2.25 In international comparisons, Tunisia appears as an "intermediate" country between the figures obtained for the developed countries (close to 10%) and those found for the developing countries (around 30X). Table 2.8 SHARE OF FIDUCIARY MONEY IN M2. INTERNATIONAL COMPARISONS (1982) Tunisia Morocco Senegal Portugal Spain Greece 21.4% 30.0% 32.2% 12.8% 9.2% 16.8% 2.26 The relatively important role of bank money in the Tunisian economy has two major consequences: (i) It has the advantage of reducing the possible scope of hoarding even if it does not by itself imply any hypothesis concerning the scale of the propensity to hoard the available stock of notes (this propensity can in some cases be high and partly offset the advantage associated with extensive use of bank money). (ii) It governs the degree of potential dependence of the second-tier banks vis-a-vis the Central Bank in the process of monetary creation. Since the compulsory reserve ratio is at present equal to zero, the theoretical value of the monetary base multiplier calculated for the aggregate banking system is given by the ratio (J., in which b is the share of currency in the money supply. 1/ 1/ For any individual bank (microeconomic approach), the value of the credit multiplier depends also on that bank's market share in the capturing of deposits.  - 50 - 2.27 At the end of 1983 the value of the theoretical monetary base multiplier was about 4.6, whereas the apparent multiplier, calculated by relating the money supply M2 to the monetary base at the same date, is slightly lower (4). Thus, because the compulsory reserve ratio is zero and the value of the ratio CurrencY is moderate, the theoretical money supply degr-_e of independence of the commercial banks with regard to the Central Bank is higher in Tunisia than in most countries of comparable development level. However, this theoretical degree would become the measure of the real degree of independence of the deposit banks only if the country were to implement a monetary base policy or, more generally, any form of monetary policy implying a causality proceeding from variations in the monetary base toward changes in the money supply. 2.28 The stability of, or even slight increase in, the share of currency in K2 is due to several factors: (i) The slowdown in the growth -- and even, at certain times, the decline in absolute value - of time deposits due to the placement policies of institutional investors (social security funds and insurance companies) (see paragraph 5.13). (ii) The occurrence of threshold phenomena, the use of bank money in the Tunisiar. economy being high in comparison with other indicators of economic development in Tunisia. (iii) The rise in the absolute numbers of payment incidents, particularly uncovered checks. This rise, which reduces confidence in bank money, is however considerably reduced, or even disappears, if we relate the number of uncovered checks to the total number of checks presented at the clearing house (this ratio has remained more or less stable over time at close to 1X). Savings in the form of bank deposits 2.29 The financial statistics published in Tunisia do not permit clear segregation of deposits held by households and those held by non financial enterprises. We can, however, obtain useful information about the trends of household financial savings by analyzing the evolution of deposits with the commercial banks, CENT and CNEL, excluding the demand deposits of the enterprises and the time deposits of the insurance companies and social security agencies. The basic data given in Table 2.9 indicate that cumulative household savings in the form of deposits have risen faster than GDP. 2.30 Assessment of household savings in light of the trend of bank deposits has to be clarified by four points which are analyzed in the following paragraphs: (i) the proportion of demand deposits in total bank deposits; (ii) the effect of the deposits of institutional depositors (insurance companies and social security funds) on the trend of time deposits; (iii) the sensitivity of the money supply trend to remittances by emigrant Tunisian workers;  - 51 - Table 2.9 Deposits with Banks, CENT and CNEL (millions of dinars: end-af-year figures) 1978 1979 1980 1981 1982 1983 Deposit Banks 1. Demand deposits 381.8 459.7 567.8 667.6 824.6 958.1 2. Households 109.2 129.0 160.9 209.0 251.8 322.2 3. Enterprises 272.6 330.7 406.8 458.6 572.8 635.9 4. Time deposits 215.1 245.1 283.5 331.0 309.9 312.1 5. Institutions 115.1 130.1 152.2 125.1 88.9 49.0 6. Others 100.0 115.0 131.3 205.9 221.0 263.1 7. Savings deposits 110.7 43.6 178.9 238.6 309.8 407.0 CENT and CNEL 8. Savings deposits 90.2 113.6 130.0 164.3 210.7 248.8 9. CENT 1/ 50.2 59.0 67.0 84.1 100.3 120.9 10. CNEL 40.0 54.6 63.0 80.2 110.4 127.9 Total deposits excluding demand deposits of enter- prises and time deposits of institutions 2/ TD millions 410.1 501.2 601.1 817.8 993.3 1241.1 Z of GDP 16.5 17.0 17.1 19.8 20.7 22.7 1/ Including foreign exchange savings accounts. 21 sum of lines (2) + (6) + (7) + (8) Source: Central Bank of Tunisia: Financial Statisti-s  -52 - (iv) the relative weights, in quasi-money, of time deposits and special savings accounts. The share of demand deposits in the total deposits of the banking system 2.31 The share of demand deposits in total deposits with the commercial banks, CENT and CNEL rose slightly during the recent period, from nearly 48% at the end of 1978 to 50% at the end of 1983. This recent development stems in large part from the decline in absolute value of time deposits of institutional depositors, partially offset by the growth of special savings accounts. 2.32 The fact that at the present time 57Z of bank resources consists of demand deposits, earning interest of 2% a year (demand deposit accounts of individuals) has to be taken into consideration in the context of the proposals relating to the interest rates scale (see paragraphs 5.22 through 5.24). The influence of institutional deposits on the trend of time deposits 2.33 The growth of quasi-money and therefore of the money supply (H2) is very sensitive to the trend of time deposits by the insurance companies and social security funds. The share of time deposits of the institutional depositors in total time deposits with commercial banks has fallen appreciably since 1980, to only 15.7% at the end of 1983. Table 2.10 SHARE OF TIME DEPOSITS OF INSTITUTIONAL INVESTORS IN TOTAL TIME DEPOSITS OF COMMERCIAL BANKS (END OF YEAR) 1978 1979 1980 1981 1982 11983 53.5% 53.1Z 53.7Z 37.8Z 28.7% 15.7% 2.34 The decline in time deposits of institutional depositors is explained by the conjunction of several factors: (i) The growing cash difficulties of the insurance companies and the social security funds. Thus, in the area of social coverage, CAVIS 1/ is in a deficit situation following extension of its field of operation to new population groups, while the liquidity surpluses of the CNSS 2/ are progressively falling for the same reason. (ii) The diversification of institutional placements. This may be a matter of diversification at the behest of the public authorities: the social security funds have reduced their time deposits with the banks in order to purchase a significant amount of capital equipment bonds. But it may involve diversification spontaneously initiated by the institutional depositors: the same secial security funds, particularly the CNSS and the CNRPS, 3/ have strengthened their presence in the low-cost housing sector. 1/ Caisse d'Assurance Vieillesse, Invalidite et Survie. 2/ Caisse Nationale de Securite Sociale. 3/ Caisse Nationale de Retraite et de Prevoyance Sociale.  - 53 - 2.35 The rising share of time deposits held by individuals and enterprises, the counterpart to the falling share of institutional depositors, should tend to strengthen the overall elasticity of supply of time deposits to interest rates payable. Thus, the institutions' placement policy results more from the constraints deriving from the regulations or from monetary policy in general, and is hence no doubt less sensitive to interest rate movements than the placement policies of individuals and enterprises. 2.36 The contribution of the insurance companies to the liquidity of the financial system, particularly of the deposit banks, has declined for three mair. reasons: (i) The insurance companies are subject to the "bond obligation." A 1979 decree of the Minister of Finance requires that at least 50% of technical reserves be placed in capital equipment bonds. The proportion of these technical reserves invested in certificates of deposit and time deposits with the banks is subject to a ceiling; (ii) The cash situation of many insurance companies has deteriorated recently owing to the imbalance of certain risks (such as the automobile insurance branch) and the inflexibility of the rating of these risks; (iii) In the insurance sector, arrears are growing, owing in particular to a sharp rise in the premium arrears of the public enterprises toward the insurance companies. 2.37 The trend in the structure of insurance company placements confirms the significant fall in the proportion of reserves held in the form of time deposits or certificates of deposit. Table 2.11 STRUCTURE OF INSURANCE COMPANY PLACEMENTS (END OF YEAR) 1981 1982 Capital Equipment Bonds 41.8% 42.4% Bonds 8.0% 7.0% Shares 22.5% 23.0% Land and buildings 12.9% 17.6% Time deposits, certificates of deposit, liquidities 14.8% 10.0% 2.38 The existence of arrears helps to explain the gap between the minimum proportion of capital equipment bonds required by the regulations (5OX) and the actual proportion held. As in the case of the social security agencies, portfolio restructuring has operated to the detriment of bank deposits and certificates of deposit in the banks and to the benefit of real-estate investments. Deposits of emigrant workers 2.39 A not inconsiderable share of the monetary components of savings takes the form of deposits of Tunisian workers abroad. The growth of emigrants' remittances is slowing down (see Annex 2) under the combined effect of several factors:  - 54 - (i) The existence of an interest rate differential between Tunisia and the international capital market which is not offset by the expectation of an appreciation of the dinar. The deposit interest rates paid in Tunisia do not encourage repatriation of foreign exchange. (ii) The economic recession and the rise in unemployment in the host countries. In this respect Tunisia is experiencing the same problems as other countries substantially dependent on emigrants' remittances (such as Morocco and Portugal). (iii) The demographics of the emigrant population, particularly its aging and the permanent integration of the younger members into the host countries. (iv) The maintenance of certain axchange control formalities which have to be complied with in order, for example, to open foreign exchange savings accounts. 2.40 Conscious of the need to slow down the rate of decrease in emigrants' remittances, the monetary authorities have sought to adapt the financial instruments offered to Tunisian workers abroad. The financial services of the Postal Department have played, and continue to play, a fundamental role in this process. Thus, since 1967, CENT (Caisse d'Epargne Nationale Tunisienne) has offered Tunisian workers abroad foi-!ign exchange savings accounts without any ceiling on deposits, paying interest one point higher than that on special savings accounts and exempt from tax. Since 1982 two new formulas have been available to Tunisian workers abroad: i) the convertible dinar account offered by all the financial institutions 1/ and currently paying 9% interest, exempt frorA tax irrespective of duration; (ii) the convertible foreign exchange account, also on general offer, which is guaranteed an interest rate (exempt from tax) equal to the interest rate paid on deposits of the same nature in the host countries. 2.41 It has to be recognized that the introduction of these new financial instruments for Tunisian workers abroad has so far produced only limited results. Thus, at December 31, 1983, holdings in foreign exchange or convertible dinars represented only 0.4% of the total quasi-money collected by the deposit banks. The lesson to be drawn from this is that financial innovation - in this case, the introduction of new financial instruments adapted to the needs of Tunisian workers abroad -- while a necessary condition, is not in itself sufficient to reverse the trend observed. It should be supplemented by reduction of the interest rate differential between Tunisia and the international capital markets and by a more active policy of mobilization of emigrant workers' savings. The other aspects of the problem, particularly the demographic dimension and the economic situation in the host countries, are outside the control of the Tunisian authorities. 1/ With the exception of the development banks.  - 55 - Special savings accounts and time deposits 2.42 The continued success of the special savings accounts is due mainly to two factors: (i) These accounts are the backbone of small savings mobilization. Thus, CENT holds about 500,000 savings accounts with an average balance per account of about TD 300 (to be compared with the ceiling of TD 5,000 which has remained unchanged since 1965). (ii) Taking into account tax exemption, the net yield of the special savings accounts is negative or very slightly positive in real terms (interest rate of 7.75% on accounts from 12 to 18 months and 9.75% on accounts at over 2 years) but nevertheless attractive in comparison with other placements of liquid savings. The success of the special savings accounts is such that the prohibition on opening more than one account per person is largely evaded and that, with the information currently available, there are no means of measuring the scope of the phenomenon or of stemming it. 2.43 The attractiveness of the special savings accounts explains their rising share of total time deposits excluding institutional deposits and savings deposits. The following figures show that during recent years this trend has been broken only in 1981. This break is probably explained by changes in the structure of borrowing interest rates that year, which was reflected in increases of 1.5 to 2 points for time deposits and 1.25 to 1.5 points for savings accounts. The data given in Table 2.12 appear to confirm that the interest rate changes have had an appreciable impact on the amount and, particularly, the composition of financial savings. Tabie 2.12 SHARE OF SPECIAL SAVIJIGS ACCOUNTS 1/ Ratio of SSAs to time deposits + SSAs) {end-of-year figures) 1978 1979 1980 1981 1982 1983 66.8 69.2 70.2 66.2 70.2 71.3 1/ Excluding insurance company and social security fund deposits. 2.44 Alongside the savings mobilized by the financial institutions, there exists in Tunisia, as in most other developing countries, a significant volume of informal savings which consist essentially of idle cash balances, savings in the form of livestock, holdings of gold, and the savings directly invested in housing. The undeniable success of housing savings in Tunisia and of the CNEL (Caisse Nationale d'Epargne-Logement), which in December 1983 had total housing savings accounts balances of TD 128 billion - has undoubtedly reduced, in comparison to what has happened in other countries, the amount of the informal savings used in the housing sector.  - 56 - Borrowing interest rate policy 2.45 Interest rates are closely managed, both borrowing rates, for which the monetary authorities set precise levels, and lending rates, which are allowed to fluctuate only within a very narrow predetermined range (in general 0.25 of a point; for a few loan operations, 0.50 of a point). The only notable exception to this rule is long-term interest rates (loans in excess of seven years). The current interest rate structure is very complicated because it combines a very fine differentiation of interest rates by sector of activity (in the case of lending rates) or by type of account (in the case of borrowing rates) with a differentiation according to term. 2.46 Since 1962 the borrowing interest rate structure has been changed nine times (see Annex A.3). The last review took place in April 1985 following the World Bank mission that prepared this report. It resulted in increases averaging 1 point in the interest rates on time deposits, certificates of deposit and special savings accounts. These increases correspond partially to the recommendations of the World Bank mission. However, it would be necessary to increase the average interest-rate level a little more, as proposed in the present repcrt, unless there were clear and solid indications of a substantial drop in the inflation rate (which does not seem very likely). 2.47 The very strict system of exchange controls allows interest rates in Tunisia to be largely independent of international interest rates, at least in terms of level. In terms of dynamics, this independence is perhaps less marked but it does exist. The empirical tests relating to this question are difficult since t'.le structure of lending and borrowing interest rates is changed too infrequently to permit comparison with international capital market rates and because the money market rates, being more volatile (they in fact fluctuate within a limited range, for example between 8.375X and 9% 1/ in the year 1984), are not very significant. These money market rates in fact represent a marginal volume of bank refinancing operations since, being higher than the Central Bank rediscounting rates, they amount for the banks to penalty rates. 2.48 Comparison of the Tunisian money market rates and the London Eurodollar interest rates confirms the absence of a strong and stable link between the two series. Thus, money market rates in Tunisia rose between the first quarter of 1982 and the second quarter of 1983, whereas Eurodollar rates fell during the same period. The reverse happened between the second and third quarters of 1983. Calculation of the correlation coefficient confirms the absence of a link between the two interest rate series: this coefficient, in quarterly averages over the period 1982-83, is only 0.084. 2.49 The exchange control system currently applied by Tunisia means that Tunisian interest rates can be fixed on the basis mainly of domestic considerations, particularly actual and anticipated inflation trends. 1/ 7.75% and 8.875%, respectively, before the last increase.  - 57 - Table 2.13 TUNISIAN AND INTERNATIONAL INTEREST RATES (quarterly averages) 1982 1983 I II III IV I II III IV Money market rate in Tunisia (minima) 8.25 8.75 8.42 8.125 8.29 8.67 8.46 8.7 Eurodollar rate, 3 months, London 14.87 15.09 12.59 9.91 9.16 9.32 10.08 9.72 2.50 To be able to evaluate accurately the present interest rate structure in real terms we would need to know two discrepancies; Ui) the difference between actual inflation and inflation as measured by the GDP deflator or the retail price index; (ii) the discrepancy, if any, between actual inflation and inflationary expectations, which must be integrated into the measurements of real interest rates. 2.51 Even though these two discrepancies are not known, it can be stated that borrowing rates in recent years have for the most part been negative. Even following the latest increase (April 1985), most of these ratis are still negative in real terms. For example, annual interest on sptcial savings accounts at 6 months to 1 year is 5.5Z (net of taxes), whereas the interest rate on time deposits and registered certificates of deposit held by individuals with the same term is 6.03%, taking into account the 11.5Z tax on income from credit balances (Imp8t sur le Revenu des Creances -- IRC) and the special solidarity levy (Contribution Exceptionnelle de Solidarite -- CES), equal to 20% of the IRC. By contrast, the interest rate on special savings accounts at more than 2 years is 9.75%, while that on time deposits and registered certificates of deposit held by individuals at more than 2 years is only 8.62% after taxes. Comparison of these after-tax interest rates with the inflation rates as measured by the GDP deflator or the retail price index leads to slightly negative or barely positive real rates even for the components of consolidated savings. Increase in borrowing rates 2.52 The proposed changes in interest rate policy are set forth in broad outline in Chapter IV (para. 4.20 and 4.30). With regard to borrowing rates, it would be desirable to apply slightly positive real rates for placements beyond 6 months. The reasoning presented here is founded on the basic hypothesis - which would be favorable if we compared it with the figures recorded in the recent past -- of actual inflation and of inflation expectations of around 8X a year. The proposals made here will, of course, have to be adjusted if it turns out that inflation remains durably higher than 8Z.  - 58 - 2.53 Despite the increase of around 1 point in borrowing interest rates introduced in April 1985, if inflation remains persistently above 8X, consideration should be given, with the ob,ect of stimulating the financial savings of households, to new adjuatments of borrowing rate levels: (i) Interest rates on time deposits and certificates of deposit (wnether registered or to bearer) at up to 2 years should rise another 2 points. Thus, time deposits of 1 year to 18 months would carry a nominal rate of 10%, i.e. about 8.6% after taxes. The real yield of this investment would thus be very slightly positive, assuming that inflation remained around 8%. (ii) Interest rates on time deposits and certificates of deposit at 3 years and over would be freed. This proposal affects a decreasing (since 1978) but still significant proportion of total time deposits managed by the banks. At the end of 1983 about 55% of the time deposits received by the deposit banks had terms of 2 years or more. Table 2.14 TIME DEPOSITS AT 2 YEARS OR OVER MANAGED BY THE DEPOSIT BANKS (as % of total time deposits) (end of year) 1975 1978 1979 1980 1981 1982 1983 60.4% 75.2% 73.8% 72.8% 63.2% 61.8% 55.2% (iii) Interest rates on special savings accounts would be raised, but by a lower percentage than the time deposit and deposit certificate rates with the object, taking into account the tax effects, of reducing the gap in favor of the special savings accounts for placements at more than 2 years from I point to about 0.5 of a point. They would rise by 1.5 points. (iv) Interest rates on demand deposits would be kept unchanged, i.e. 1% for demand deposits of enterprises and 2% for those of individuals. (v) The rise in borrowing rates would only partially affect emigrants' deposits in foreign exchange or convertible dinars, which already enjoy interest rate advantages and tax exemptions. Thus, the interest rate on deposits in convertible dinars of Tunisian workers abroad remain at its present level of 10.5X. The interest rates on foreign exchange savings accounts would have to correspond to the interest rates on deposits with similar characteristics and in the same currencies in other countries; they would have to be adjusted fairly frequently (for example, every three months) to reflect changes in the interest rate of each curren y. 2.54 The effect of the proposed increases in borrowing interest rates on the aggregate volume of private savings and on the average propensity to save of households is uncertain. It has already been suggested that propensity to save is influenced more by variations in real income than by interest rate movements. On the other hand, the proposed rise in borrowing rates should increase the share of financial savings in total savings and the proportion of  - 59 - household savings mobilized by the financial intermediaries. This would make it possible to reduce low-yield direct investment of informal savings (certain real-estate assets and durable goods) and to raise overall investment efficiency. Moreover, tne rise in borrowing interest rates would at least go some way toward slowing down the outflows of capital and the failures to repatriate export receipts that have taken place in spite of exchange control. 2.55 The impact of the proposed measures on the average cost of the banks' resources can be determined only under certain hypotheses. It is possible that some degree of harmonization among the banks will limit the rise in borrowing rates, freed in the case of time deposits at 2 years or more, or bring it into line with the rate for time deposits at less than 2 years. Under this simplifying hypothesis, since demand deposits represent around 60% of total bank money (including quasi-money) and special savings accounts represent about 202 of that total, the recommended increases should, for a given structure of the banks' liabilities, lead to an increase in the average cost of bank resources on the order of 0.5-0.7 of a point. 2.56 The proposed measures will have the effect, in the medium and long term, of modifying the structure of bank resources by increasing the proportion of time deposits and special savings accounts, since their yield to savers will rise in comparison to that of demand deposits. The result of this movement would be to increase the average cost of bank resources a little more. The figure of 0.7 of a point must therefore be regarded, in the medium and long term, as a minimum figure. To estimate the discrepancy between this floor and the accual figure, we would need to know -- which is not the case the sensitivity of the term structure of the banks' liabilities with respect to the term structure of borrowing interest rates. In any event, this movement would be gradual and it would therefore take time for the rise in the average cost of bank resources to exceed 1 point. Measures supplementing the interest rate increases 2.57 It is recommended in Chapter IV that greater flexibility be introduced into lending interest rates in line with the needs of monetary policy. Consequently, borrowing rates would also have to become more flexible. The necessary flexibility would be obtained in part by freeing the interest rates on time deposits and certificates of deposit at 2 years or more, as proposed in paragraph 2.53. It should be possible also to modify the interest rates on the other categories of time deposits and savings accounts without difficulty. It is therefore desirable to introduce a system of basic rates to which deposit interest rates would be tied (except for the freed rates and the rates on demand deposits). As explained in Chapter IV, each of the interest rates to which the system would be applied would be equal to the basic rate plus or less a given margin which would be more stable than the basic rate. To change a particular interest rate under this system it would suffice to change the basic rate. 2.58 In a financial system in which the banks are very reluctant to engage in term "conversion," in particular for fear of the risk of illiqjidity, consolidation of bank liabilities is necessary to the growth of medium- and long-term credit. This observation applies perfectly to the case of Tunisia, where economic development presupposes an increase in the share of medium- and long-term loans in total loans made by the deposit banks.  - 60 - 2.59 With the object of reducing the relative cost of time deposits and special savings accounts to the banks and avoiding the latter being provoked into refusing to receive new time deposits, three recommendations are offered: (i) The restoration of compulsory reserve ratios in excess of zero in order to control the growth of bank liquidity (Chapter III) should be accompanied by marked differentiation according to the nature of the deposits. Consideration could be given to introducing a system of three reserve ratio levels: one level for demand deposits; another, lower level for special savings accounts and time deposits up to 12 months; - a third level, even lower and perhaps even zero, for time deposits and special savings accounts of over 12 months and emigrants' deposits regardless of term. (ii) With the same objective, the ratio of compulsory investment in capital equipment bonds and CNEL bonds should be modulated to make it significantly lower for emigrants' deposits, time deposits and special savings accounts than for demand deposits. Ciii) The policy of placing a ceiling on credit, suggested in Chapter IV, would have to take account of the effort of the banks in mobilizing stable resources. The credit ceiling rules imposed on each bank would be determined in light of the growth of the demand deposits, special savings accounts and time deposits with that particular bank, and of its equity funds, greater weights being accorded to term accounts, emigrants' deposits and equity funds. 2.60 The system of weighting of deposits used in calculating the ceilings for each bank, referred to in the preceding paragraph, could for example be as follows: (1.0) for demand deposits and time accountr up to 12 months; (1.5) for time accounts of over 12 months; (2.0) for emigrants' deposits, regardless of term; (3.0) for equity funds. If this system were to be adopted, the amount l1, in dinars, of the increase in lending authorized for bank A in the course of year n would be derived from the followint formula: 1 x dv-l + 1,5 x dt- + 2 x den- + 3 x ff-l 1 x D 1 + 1,5 x D 2 x De 1 + 3 x FL-1 where - dn-1, d-l, dn-la and ffll represent total deposits at up e to 12 months, at more than 12 months, emigrants' deposits and equity funds, respectively, at bank A at the end of the year n-i; - Dn71, D-1, and DE-1 and Fnl1 represent total deposits at  - 61 - up to 12 months, at more than 12 months, emigrants' deposits and equity funds, respectively, held by all the deposit banks at the end of year n-i; and - LJ represents the total increase in credit authorized by the authorities for all the deposits banks for year n. The weighting structure would have to be stable to some degree over time. It could, however, be changed in the event of serious current balance of payments problems, which would lead the authorities to strengthen the advantages accorded to emigrants' deposits, etc. 2.61 The suggested differentiation of a number of essential instruments of monetary policy (credit ceilings, compulsory reserves, compulsory investment ratios) should make it possible to offset, from the point of view of the banks, the suggested change in the term structure of borrowing interest rates but no doubt also to go beyond simple offsetting by inducing them to consolidate their liabilities and therefore their assets. It should also lead the banks to step up their efforts to collect emigrants' deposits, an essential component at a time when Tunisia is increasingly suffering from external constraints. 2.62 The suggested increase in borrowing rates must be accompanied by changes in the interest rates on and the taxation of financial market placements (Chapter IX). Promotion of the financial market calls for the securing and maintenance of an after-tax yield differential sufficient to compensate for the financial market risks (risks of capital losses if interest rates rise for the liquid segments of the market, risks of illiquidity for the other segments, and so on). Thr place of housing savings in the mobilization of household savings 2.63 In the area of housing savings, a very delicate one for most developing countries, Tunisia has registered impressive success since 1973-74, with a very sharp rise in the funds captured by CNEL. From DIecember 1975 to December 1983, total balances on housing savings accounts rose from TD 4.4 billion to TD 128 billion. The growtl of housing savings wais irregular over the period 1976-83: from an original very high level (+224% from December 1975 to December 1976), the growth rate declined appreciably from 1976 to 1980 and then rose again between 1980 and 1982 (+38% in 1982). During the recent period, the growth of funds collected by CNEL (16% in 1983 and 15% in 1984) was much slower. Despite the fact that there was also a slowdown in the growth of other deposits, this is certainly a sign that the housing savings system is "running out of steam" to some extent; the causes of this development need to be analyzed more closely. 2.64 It is interesting to compare the respective market shares of CNEL and CENT, in the medium and long term, in the a*bilization of private savings. From 1975 to 1983 total savings balances wi_h CENT rose fourfold, whereas savings with CNEL rose, in nominal terms, by a fa_tor of 30. At the end of 1984, CNEL was mobilizing a larger volumc of savings than CENT. 2.65 Some of the reasons for the success of housing savings in Tunisia nxist also in most other developing countries; others stem from the specific characteristics of the system installed by the Tunisian authorities.  - 62 - 2.66 The Tunisian saver, like savers in most other developing countries, has a predilection for investment in housing and access to ownership. The housing savings system has made it possible to channel part of the informal savings tbat were invested directly by the agents in the housing sector back into formal savings. The success of housing saving is due mainly to the attractiveness to the Tunisian saver of the earmarked savings accounts. This attractiveness is the justification for introducing new earmarked savings instruments which supplement the housing savings formula without claiming to equal its success. 2.67 The housing savings instrument offered to the Tunisian saver is moreover quite attractive: a deposit interest rate of 6Z or 7X a year (including the bonus paid by the State), depending on whether the account is opened in dinars or in foreign currency; a contractual commitment to grant a loan at the end of 4 or 5 years, depending on the case; a "multiplier" (ratio between the loan granted and the amount saved, including capitalized interest) equal to 2 and sometimes higher. In addition, many savers are attracted by the flexibility of the proposed formula since they can obtain a loan, on less advantageous terms of course, before the end of the contractual period. 2.68 The Tunisian housing savings system has in fact been experiencing a serious crisis since 1983. This crisis differs in its causes from the crises in comparable countries. For example, in some cases the housing savings system has failed because of financial disequilibria inherent in the system installed (excessively high "multipliers," poor evaluation of the time profile of the loans granted and of the deposits made, and so on). In Tunisia the difficulties stem from a bottleneck on the serviced sites and new construction market and thus from a poor match between the "physical market" and the amount of finance available. Because of the scarcity of newly-built housing, savers cannot today use the loans to which there are contractually entitled. Of the 128,000 housing savings contracts in force, 26,000 have exceeded the period of four years. Because of the new construction bottleneck, CNEL finds itself both possessing excessive liquidity -- it is becoming a "potential structural lender" -- and unable to satisfy the credit demand of its clients. CNEL is in a way a victim of its own success. 2.69 The present situation of housing savings is disturbing, since with the de facto breach of the contractual coumitment and the lengthening of the queue of savers, confidence in the system is likely to diminish rapidly. Such a trend would bring about a decline in housing savings in Tunisia that would be difficult to reverse. To avoid the flight of savers aware that the likelihood of obtaining a loan is growing increasingly small, a number of measures need to be taken rapidly (some of which were developed by the work of the Inter-Ministerial Commission on Housing Savings that met in 1983): (i) CNEL should diversify its upstream placements by granting loans to site developers and thereby removing certain constraints on the new construction market. (ii) Clients should be able to use housing savings to obtain loans for the purchase of sites and the renovation and maintenance of existing dwellings. (iii) A client who is unable to use the contract loan by the end of the period fixed should receive the highest interest rate applicable to time deposits on his housing savings account.  - 63 - 2.70 At present the deposit banks also offer savers a facility known as "housing savings" but differing significantly from the true housing savings received by CNEL in that there is no contractual commitment by the bank to grant the loan. The de facto blockage of the true housing savings system tends, however, to induce a similarity in some ways between the financial facility of the banks and that offered by CNEL. In the area of housing finance, the banks offer "status loans" (credits-standing) for high-income borrowers which differ from the housing savings collected by CNEL in many ways (loan term, interest rate, personal contribution required, and so). The "status loans" do not belong to the category of earmarked contractual savings. But the de facto blockage of CNEL tends to confer on housing savings in the strict sense the same "non contractual" dimension as status loans. Financial instruments offered to savers 2.71 The Tunisian financial system is, in the analytical sense, "over-determined" by the monetary authorities, who control both the money supply (through a regulatory procedure which, as indicated in Chapter IV, is poorly adapted to overall control) and interest rates. In addition, the monetary authorities exercise close surveillance over the introduction of new financing facilities. In Tunisia, financial innovation is principally public, i.e. is introduced by the public authorities, and financial innovation at the initiative of the deposit banks ("private" innovation) plays a secondary role. 2.72 The new financial facilities introduced by the public authorities since 1981 have three features in common: (i) They correspond to earmarked savings formulas, so dear to the eyes of the Tunisian saver. (ii) They owe their attractiveness and their originality to the tax advantages they enjoy; this indicates that public financial innovation, in Tunisia as in other countries, has an essential fiscal content and that it swells the total volume of tax benefits (i.e. of "tax expenditures"). (iii) They are offered by all the financial institutions (by the deposit banks, often also by CENT and the authorized financial establishments). 2.73 The major tax incentive to saving consists of Law 62-75 of December 1962, which has since been amended many times. Under this law, profits or other income reinvested in real assets (construction or extension of buildings or of industrial, agricultural or commercial plant) or in financial assets (shares and bonds) are deductible from taxable income at the rate of 30% of annual taxable income in the case of individuals subject to the State Personal Contribution (Contribution Personnelle d'Etat -- CPE) and 50% in the case of juridical persons (subject, to the tax on industrial and commercial profits, the tax on non commercial profits, etc.). The three financial instruments introduced since 1982 incorporate this general provision into various earmarked savings formulas: (i) The employment savings (Spargne-emploi) accounts opened at deposit banks or other authorized financial establishments serve to build up the  - 64 - self-financing required for the execution of small projects (TD 10,000-20,000) that fall within Tunisia's employment development policy. (ii) The project promotion savings (6pargne-projet) accounts, which are restricted to individuals, are intended to earmark funds intended for the financing of approved projects or projects eligible for assistance by the FNPAPM (Fonds National de la Promotion de l'Artisanat et des Petits Metiers), approved by the API (Agence de Promotion des Investissements), by the APIA (Agence de Promotion des Investissements Agricoles), etc. (iii) The investment savings (4pargne-investissement) accounts, which are open to both individuals and juridical persons, are used to acquire securities of approved companies which must be blocked for five years in order to qualify for the tax benefits. In 1985 the authorities started to consider the introduction of a system of study savings (epargne-etudes) accounts. Under this system, savers will have the chance to obtain loans in an amount equal to double that of their accumulated savings, for use in the financing of study expenditures by designated beneficiaries. 2.74 It is still too early to assess the impact of public financial innovation in Tunisia during the recent period, since several of the earmarked-savings formulas have not been implemented until recently. The most complete information relates to employment savings accounts opened since the end of 1982. As of June 1983, 104 employment savings contracts had been signed (nearly 50Z of them with two banks, the STP and the BIAT). 2.75 There are no doubt advantages in linking the benefits of Law 62-75 to earmarked savings formulas in order to promote small and medium-sized projects and development of the stock market. Nevertheless, it would be difficult to go any further in this direction, for three reasons; (i) Increasing the number of earmarked savings formulas would have the disadvantage of fragmenting the financial system and reducing its efficiency. (ii) In a period when it is necessary to sustain public savings it is desirable to limit "fiscal expenditures" in the form of the tax advantages accorded to savings. It is not a matter of reconsidering the advantages associated with Law 62-75 but of keeping close control over the total magnitude of the losses of taxable revenue. (iii) The public financing innovations introduced since 1982 are particularly attractive to taxpayers subject to the CPE, the patente or any other form of direct taxation. They are thus addressed at persons with medium or high incomes but hardly to small savers. The range of available financial instruments should no doubt be supplemented by a new savings instrument reserved to individuals not liable to the CPE or with taxable incomes not exceeding a predetermined amount. 2.74 Financial innovation at the initiative of the deposit banks, the main component of "private" financial innovation, is poorly developed in Tunisia because of the close supervision exercised by the monetary authorities and the  - 65 - de facto limits placed on competition between banks. Of particular interest among recent financial innovations are formulas combining deposit at a bank with life insurance (such as the "El Amen" facility offered since 1981 by Credit Foncier et Commercial de Tunisie, which has promoted it through a vast advertising campaign). Because of the increasing number of uncovered checks and the decline in confidence in payment by check, a number of banks are currently studying the possibility of introducing a system of gasoline checks (cheques-essence). 2.77 Certain development banks and the offshore banks have played an important role in the introduction of new financing techniques in Tunisia. They can be expected to continue to perform this role and to serve as vehicles for the dissemination in Tunisia of financial innovations that have appeared in other financial systems or on the international capital markets. However, the monetary authorities retain substantive control of the pace and form of financial innovation. 2.78 The policy on financial instruments in Tunisia could, in the short or medium term, be constructed around the following principles: Ci) Adaptation of housing savings (section E of this chapter). (ii) Promotion of the three types of earmarked savings accounts introduced since 1982 (employment savings, project savings, and investment savings); however, no new instruments of this kind should be created, to avoid fragmenting the financial system or excessively reducing the direct taxation base. (iii) Introduction, following more thorough study, of a financial instrument similar to the special savings accounts, to be offered by CENT and, if they were interested, also by the deposit banks, but, unlike the special savings accounts, reserved to individuals with taxable incomes below a predetermined amount (either they would not have to pay the CPE or its amount would be limited to a maximum set by the monetary authorities). Since the tax advantages associated with this instrument would by definition be zero or negligible, its pretax yield would need to be higher than that at present offered on special savings accounts, time deposits or certificates of deposit. Part of the remuneration of this new financial instrument intended for low-income individuals could derive, exceptionally, from partial or total indexing of the capital to the price index. The policy of the banks with regard to the receiving of deposits 2.79 The phenomenon of "exclusion" of savers through the minimum balance requirements imposed by the banks on demand and time accounts exists in Tunisia but is less developed there chan in the other countries of comparable development (Morocco, Ivory Coast, etc.). In theory, any demand, time or savings account can be opened with 1 dinar. In practice, the deposit banks avoid inflating their costs by accepting small deposits and frequently impose a minimum of TD 200-300 to open an account. In doing this they leave the major role in mobilizing small deposits to the Postal Service (postal checking accounts and CENT). 2.80 The new earmarked savings accounts (project savings, employment  - 66 - savings, and investment savings) all require a minimum of TD 20 to open the account and for every debit or credit transaction; this seems reasonable in view of the specific nature of these accounts. Care should be taken to ensure that the scope of "exclusion" of savers through the policy concerning the opening of accounts remains limited in the future, as it is today. 2.81 Savings can also be "excluded" in another way: the ceiling on special savings accounts opened with the deposit banks or CENT. This ceiling, which has been TD 5,000 since 1965, in practice leads certain savers to disregard the regulations and to open accounts with several financial institutions. This applies in particular to clients of deposit banks, in which the average balance on special savings accounts is TD 3,000. The ceiling was very high when it was set in 1965 and it remains fairly high today in comparison with the average individual wage. Rather than increase the ceiling on special savings accounts, which would favor high-income savers, it would be preferable to introduce a type of savings account specially tailored to low-income savers. 2.82 Mention must be made of a tax provision which penalizes small cash payments into the banks. There is a stamp duty on cash payments (but not on withdrawals) of TD 0.05 regardless of amount. Independently of the policy of the deposit banks, this rule can discourage the depositing of cash sums hoarded by the poorer classes. Even if it has the advantage of strengthening the use of checks and bank money in the economy, it should undoubtedly be abolished. 2.83 The policy of establishing new bank windows, introduced by the Central Bank of Tunisia by means of a basic circular of 1979, is based on a principle that the Central Bank should not retreat from but should rather strengthen. It makes the opening of new bank windows in areas that already possess banking facilities conditional on the establishment of windows in areas where bank facilities are inadequate or nonexistent. According to the 1979 circular, "the Central Bank of Tunisia shall not give its agreement in principle to the annual program of opening of branches (by each bank) unless the program provides for the opening of at least one branch or office in a locality where banking facilities are totally lacking ...". The proportion currently applied is as follows: for an annual program comprising a maximum of five new openings, at least one window must be located in a region that lacks banking facilities. 2.84 For lack of precise information on bank windows opened ior specific periods, we have to study the trend in number of permanent windows. Table 2.15 Number of permanent bank windows (deposit banks) (end of year, unless otherwise indicated) 1981 1982 1983 May 1984 273 284 301 310  - 67 - Between 1981 and 1983 the number of bank windows grew at an average rate of 5.0% a year, i.e. about double the population growth and higher than average volume growth of GDP. The 310 permanent bank windows in May 1984 were distributed unequally among the deposit banks in operation. 2.85 An international comparison indicates that the proportion of bank facilities in the Tunisian economy is apparently satisfactory. Table 2.16 Number of inhabitants per permanent bank window (1982) Tunisia Ivory Coast Morocco 23,600 40,600 32,260 2.86 Other consideration' suggest that the Tunisian economy is under-provided with banking facilities: (i) When new bank windows are opened, the "net savings contribution effect" prevails over the "transfer from other placements" effect. The establishment of new bank windows may thus favorably affect the average propensity to save of households and undoubtedly influences the share of such savings mobiLized by the financial institutions. (ii) The bank windows are concentrated in a few banks: in May 1984 the three "large" banks -- Banque Nationale de Tunisie (BNT), Societe Tunisienne de Banque (STB) and Banque du Sud (BS) -- accounted for 57% of the number of bank windows, whereas the Banque Franco-Tunisienne (CFT) had only one branch (in Tunis) and the Arab-Tunisian Bank (ATB) three branches, two of them in Tunis. (iii) The 1979 circular has not been in effect long enough to have corrected the spatial concentration of new bank branches, particularly on the coast. Mention must, however, be made of the effort of the BNT, the leading bank in the mobilization of rural savings, to disperse its new branches across the country. 2.87 In order to speed up the opening of new bank windows, particularly in areas that lack banking facilities, the constraint measures based on the 1979 circular referred to in paragraph 2.83 need ~o be accompanied by incentive measures. Since the "breakeven point" on windows established in underprivileged areas is not as a rule reached until they have been in operation for two or three years, it would be useful to link temporary tax advantages to the opening of new branches in under-served areas, such as accelerated depreciation of capital expenditure. 2.88 The mobilization of rural savings calls for an active policy of establishment of new bank branches and suitable organization of the agricultural credit agencies. At the present time rural savings are collected chiefly through two neztworks, the financial services of the Post Office and the BNT. The BNT moreover effects a net redistribution of resources favorable to the agricultural sector, raising 10% of its resources in that sector but channeling 30% of its placements to it.  - 68 - Chapter III BANKING SYSTEM INSTITUTIONS A. The Structure of the Tunisian Financial System 3.01 Tunisia's financial system is well developed and fairly diversified. At the beginning of 1985 it comprised; - the Central Bank, - ten deposit banks, - nine investment banks, - two specialized savings institutions, - one leasing company, - seven offshore banks. In addition to these major institutions there are the Postal Checking Center, six portfolio management agencies, six agency offices of foreign banks, and the stock exchange. 3.02 At the end of 1984 the assets of the Central Bank were equal to nearly half the total assets of the deposit banks and exceeded by about 80% the consolidated assets of the investment banks and other financial institutions. These figures reflect, essentially, the relative importance of Central Bank loans to the Government and the other banks and of its international reserves. However, the role of the Central Bank in the Tunisian financial system has to be evaluated in light also of its very extensive powers of regulation of banking operations and prior approval of loans, factors not reflected in its balance sheet. 3.03 The deposit banks are the main source of domestic loans. In spite of certain constraints, the deposit banks can be regarded as true full-service banks: they receive deposits of all types; grant a substantial volume of mediumr and long-term loans (about 30% of their total credit to the economy); absorb nearly half the total refinancing facilities of the Central Bank; effect operations in special resources supplied by the Government or raised abroad; are the almost exclusive intermediaries in exchange operations with the exterior; hold a large portfolio of capital participations in enterprises; control portfolio management companies, and are the only intermediaries in ctock exchange operations. In recent years, with the creation of new development banks, the deposit banks' share in financing the Tunisian economy has declined slightly: the total amount of their outstanding credit balances on the Government, assistance to the economy and securities portfolios was 4.0 times that of the other financial establishments at the end of 1980 and 3.3 times at the end of 1983. However, this trend is unlikely to be maintained in the next few years. The new investment banks will not continue to have the same scope for rapid expansion after using up their substantial initial capital injections, which have been the major financial base of their recent operations. 3.04 The investment banks group comprises: the Banque de D4veloppement Economigue de Tunisie (EBDET), the oldest of the development banks, which has  - 69 - played an importalat role in investment financing, particularly in the industrial sector, including the SHEs; the BanqueNationale de Developpement Touristique (BNDT), converted from the former Compagnie FinanciEre du Tourisme (COFIT), which concentrates on hotel loans and other tourism-sector loans and participations; the Banque Nationale du Dgveloppement Agricole (BNDA), established recently for the purpose of financing mainly large agricultural investments and agroindustrial projects; and five mixed banks, with equal capital participation by the Tunisian Government and another Arab country; Societe Tuniso-Saoudienne d'Investissement et de Developpement (STUSID), Banque Tuniso-Koweitienne de Developpement (BTDK), Banque Tuniso-Qatarienne d'Investissement (BTQI), Banque de Tunisie et des Emirats d'Investissement (BTEI), Banque de Coopgration du Maghreb Arabe (BCMA), and Banque Arabe Tuniso-Libyenne de Developpement et de Commerce (BTLD). 3.05 The savings institutions are the Caisse d'Epargne Nationale Tunisienne (CENT) and the Caisse Nationale d'Epargne-Logement (CNEL). 3.06 The main problems of the financial system concern: (i) the resources of the various types of banking institutions, and (ii) banking specialization, competition, and the establishment of new banks. These points are dealt with in the following sections. B. Resources of the Banking Institutions Structure of deposit-bank and investment-bank resources 3.07 The deposit banks are in a distinctly more favorable situation than the development banks in the raising of resources. About two-thirds of the total resources of the deposit banks comes from demand, time and savings account deposits. Moreover, the deposit banks enjoy Central Bank rediscounting and advance facilities up to a limit of 17.5% of their aggregate deposits (see Chapter IV). They also have access, as do the development banks, to special resources of the Government, or resources raised abroad by the Government, to finance certain types of selective credits. The special resources, utilized mainly by the National Bank of Tunisia to finance agricultural loans, were equal at the end of 1983 to 9.3% of the total assets of the deposit banks. The equity funds of the deposit banks financed only 6.5% of their total assets (see Table 3.1, which does not however give a complete picture since it does not include the resources corresponding to paper rediscounted by the Central Bank). 3.08 As a counterpart to their right to receive deposits, the connercial banks are subject to certain constraints. For example, they are required to place 25% of their deposits in public securities (including CNEL certificates) at interest rates below those Bank loans. In spite of these constraints, the investment banks generally enjoy distinctly less favorable conditions than the deposit banks as regards raising and average cost of resources. The investment banks are not allowed to accept deposits (except, within very narrow limits, for accounts used by their clients) and do not have access to Central Bank refinancing (except for limited rediscounting facilities in favor of BDET). They finance their operations mainly from (i) equity funds; (ii) the issue of obligations; and (iii) special resources furnished or raised abroad by the Government.  - 70 - Table 3.1 RESOURCE STRUCTURE OF DEPOSIT BANKS (End-of-year figures) 1980 1981 1982 1983 1984 1980 1981 1982 1983 _--(millions of dinars) --- ----(percentages)--