In this article we will discuss about:- 1. Meaning of Financial Dualism 2. Effects of Financial Dualism 3. Suggestions to Reduce Financial Dualism.
Meaning of Financial Dualism:
Professor Myint has developed the theory of financial dualism. Financial dualism means the coexistence of organised and unorganised money market in the LDCs. The organised money market consists of the central bank, the commercial banks, the cooperative societies and banks, the foreign banks, and other financial institutions like agricultural finance corporation (as NAB ARD in India), industrial finance corporation (like the IFCI in India), the insurance companies (such as LIC, GIC, etc. in India), and the development banks (like IDBI, SIDBI, etc. in India).
The unorganised money market includes indigenous bankers, moneylenders, both professional and non-professional, traders, merchants, landlords, friends and relatives, pawnbrokers, nidhis and chit funds.
The unorganised money market is characterised by:
(i) Personal touch between the moneylenders and borrowers;
(ii) Informality in dealing with borrowers by the moneylenders;
(iii) Flexibility in loan transactions;
(iv) Multiplicity of lending activities, i.e. combining moneylending with other economic activities such as trading;
(v) Multiplicity of interest rates â€” the interest rate varying with the need of the borrower, the amount of loan, the time for which it is needed, and the nature of security;
(vi) Defective system of maintaining accounts â€” receipts are not issued for interest charged and the principal repaid; and
(vii) Utmost secrecy in maintaining accounts and lending procedures.
Effects of Financial Dualism:
The existence of such financial dualism in the money market of an LDC affects its economy in the following ways:
Interest Rate Differences. Financial dualism leads to the existence of different interest rates in the organised and unorganised money markets in such economies. The rate of interest in the organised money market in the traditional sector is much higher than that in the organised money market in the modern sector.
The unorganised money market consisting of the non-institutional lenders, such as the village moneylenders, landlords, shopkeepers, traders or the combination of some of them, charge very high interest rates on loans.
The main reason is that there is a real shortage of savings in the traditional sector as substantial amount of savings is hoarded in gold and jewellery. Even though risks and costs of lending money to a large number of small borrowers are very high, yet there are other contributory factors arising from imperfections in this unorganised money market. The village shopkeepers, landlords, moneylenders and traders occupy strategic positions in the village economy and create monopoly powers over the peasants.
These arise because of personal and informal dealings with borrowers, flexibility in loan transactions, and blending of money-lending with other types of activities such as selling of goods. “The high rates of interest which the peasants have to pay are not only formal interest charges but also in considerable part concealed charges obtained through manipulating the prices of the commodities which the peasants buy or sell. Concealed charges may take the form of very high prices for goods on credit terms at the local shop or the obligation to repay the landlord the loans advanced with a specified amount of the crop at harvest.”
On the other hand, in the organised money market of the LDCs, the interest rates are low and credit facilities are abundant. The organised money market consists of the commercial banks and other financial institutions which lend short-term credit at low interest rates to the modern business sector consisting of the big foreign-owned enterprises in the export industries, the government and the large-scale modern manufacturing enterprises.
(i) Inflation and Balance of Payments Pressures:
The LDCs are faced with chronic domestic inflation and balance of payments difficulties. As a result, small business units such as peasants, small traders, handicraft producers, etc. in the traditional sector have to face not only high interest rates but also inaccessibility to foreign exchange and imports. The LDCs have attained monetary independence with the establishment of their own central banks.
They have introduced foreign exchange controls and have restricted profit remittances and transfer of funds by foreign commercial banks. As a result, the organised money market of the LDCs has been separated from the world capital market. Coupled with this, they have been following cheap money policy.
This has led to the paradoxical situation in which the central banks in the capital-scarce LDCs are maintaining low interest rates than those prevailing in the capital-rich developed countries thereby overvaluing their exchange rates.
They fear that devaluation will lead to repeated devaluation of their currencies and to inflationary pressures. Thus the LDCs are faced with inflationary pressures, declining foreign exchange reserves and balance of payments pressures. Thus there is a chronic excess demand for foreign exchange at the overvalued exchange rates.
To overcome this, they have concentrated on foreign exchange and import control and on monetary and fiscal measures and direct controls.
(ii) Adverse Effects of Fiscal and Monetary Policies:
Financial dualism has led to aggravation of the economic dualism between the traditional sector and the modern industrial sector. These fiscal and monetary policies have tended to favour the modern industrial sector as against the traditional sector. The cheap money policy by maintaining an artificially low interest rates has made credit available to large industrial concerns at favourable terms.
The low interest rates have discouraged the flow of capital funds from abroad and savings from within the country, but have created an excess demand for loans. Thus the bulk of domestic savings at low interest rates have flowed to the modern industrial sector.
This has reduced the supply of capital to the traditional small industries and the agricultural sector which have to get it at higher interest rates. Consequently, the size of monetary transactions has been reduced and non-monetary transactions have continued to increase.
(iii) Adverse Effects of Controls:
Further, the imposition of controls on foreign exchange and imports to correct the adverse balance of payments have benefited the modern industrial sector as against the traditional sector. The modern sector is usually allocated the major portion of the available foreign exchange and the manufacturing industries are encouraged to adopt highly capital-intensive methods of production because the imported capital goods are obtained cheaply at the overvalued exchange rates. Thus there is a strong incentive to substitute cheaper imported capital goods for domestic labour.
The agricultural and small-scale sectors suffer from the foreign exchange and import controls on two counts: first, they get imported consumer goods at high prices, and second, they fail to obtain the foreign exchange and import permits easily because of red-tapism and corruption prevailing in the LDCs.
Government control over the scarce supply of capital have also retarded the growth of financial intermediaries in the LDCs. These controls favour the large manufacturing units and banks. They discriminate against the small borrowers and the moneylenders who provide credit to the small borrowers.
The government believes that capital funds invested only in durable capital goods and modern machinery are productive, while those invested in financing agriculture and trading activities are unproductive.
(iv) Inimical Public Policies:
The traditional sector also suffers because the government expenditure on public services favours the urban centres as against the rural areas. Public services like transport, communications and electric power are available more readily and at favourable terms to the modern industrial sector than to the traditional sector.
The governments in some of the LDCs have tried to improve credit facilities in the traditional sector by establishing agricultural banks and cooperative credit societies and by passing usury laws. But these tend to take the form of supplying a limited amount of subsidized loans through the cooperative societies to some highly favoured ‘model villages’. These seemingly impressive ‘show pieces’ however have no effect on lowering the high rates of interest which prevail in the rest of the traditional sector. It has restricted the growth of banks in rural areas and, in turn, the use of bank credit.
According to Myint, the efforts made to control the activities of the moneylenders and to provide cheap and easy credit in the traditional sector through commercial banks and cooperative credit societies have failed due to:
(a) The high overhead cost and salaries of the officials of the commercial banks in rural areas;
(b) The red- tapism in dealing with small borrowers according to the rigid rules of creditworthiness;
(c) The lack of coordination between the head office and branches; and
(d) The supply of limited amounts of subsidized loans through cooperative credit societies to some favoured parts of the rural sector.
(v) Retards the Growth of Capital Market:
All this has led to malallocation of resources between the modern and the traditional sectors and to the obstruction of the development of an integrated domestic capital market in the LDCs. With the multiplicity of government controls, the free market for credit has developed into the black market. Domestic inflation along with overvalued exchange rates have led to speculative flight of capital abroad.
In countries which have tried to stop this, the capital funds have been channelized into the purchase of gold, jewellery, real estate and into speculative activities. This is because of the cheap money policy which offers low interest rates to the holders of funds for investment purposes. This stands in the way of the growth of an effective capital market.
Further, credit discrimination against trading activities also stands in the way of the development of an integrated capital market in the LDCs. Due to the non-availability of sufficient capital funds and high costs of holding stocks, the traders have to hold a much lower level of stock of commodities and circulating capital. As a result, the wholesale and retail prices are widened.
Suggestions to Reduce Financial Dualism:
In order to reduce financial dualism in LDCs, a number of measures can be suggested:
1. Integration of Organised and Unorganised Money Markets:
The organised and unorganised money markets should be properly integrated. For this, the commercial banks should be encouraged to open branches in rural areas, as has been done in India by establishing Regional Rural Banks and Lead Banks.
2. Strengthening of Co-operatives:
Co-operative societies and cooperative banks should be strengthened so as to enable them to compete more effectively with moneylenders and indigenous bankers.
3. Multi-agency Approach:
A multi-agency approach should be adopted in the unorganised rural sector where farmers should be advanced loans, seeds, fertilisers, instruments, cattle, etc. and should be helped in providing marketing and trading facilities.
4. Raising Official Interest Rates:
Prof. Myint suggests that such countries should raise official interest rates in their organised credit markets high enough to reflect their existing shortage of capital funds. This would encourage the growth of an integrated domestic capital market which can effectively attract savings from within the country and from abroad.
It would also help to equate the available supply of savings to the demand for loans including the demand for funds by the moneylenders to be re-lent to the unorganised credit market.
5. Creation of an Integrated Capital Market:
Prof. Myint further suggests the creation of a more integrated domestic capital market so that free access on equal terms to capital funds could be provided both to the modern and traditional sectors. This would also reduce the malallocation of resources between the two sectors.
The interest rates in the traditional sector should be reduced by providing unlimited access to credit funds on equal terms both to the cooperatives and the moneylenders so that they can compete to lower the interest rates for the small borrowers.