Are banks the bad guys in the mobile money innovation debate?

Are banks the bad guys in the mobile money innovation debate?

Greek lessons

Greece’s central bank governor, George Provopoulos, had some harsh words for his compatriots on Tuesday as he exhorted them to break with the past and do what is necessary to right the country’s fiscal and economic situation.

To turn this situation around is not a short-term proposition, Provopoulos said: “On the contrary, what is needed is a persistent and systematic effort, an effort that is sustained, concerted and groundbreaking. Overcoming the crisis will, in other words, require a break with the past.”

But it was his catalogue of Greece’s shortcomings – the ‘recipes of the past’ – that was perhaps the harshest. These include:

· Myopic focus on the present to the detriment of the future

· Consumption behaviour verging on overindulgence that exceeds productive capacity of the economy by far

· Selective and "at will" compliance with laws and regulations

· Shifting of responsibility onto others

· Refusal to make the slightest effort towards consensus-building

· Dogmatic interpretations of reality

· Claims to maintain acquired privileges that go against the interest of society as a whole

· Short-termism and an easy-profit culture

Does any of this sound familiar?

While it might be tempting to say “those poor, misguided Greeks”, this same list of failings could apply equally well in whole or in part to other countries.

How Mobile Money can transform lives

What is Kenya the world leader in? Coffee production? Glorious beaches? Political instability? Crazy bus drivers? It certainly scores highly in all of these. But in economic terms its main recent success has been a mobile money transfer scheme called M-Pesa. Established by Safaricom, Kenya’s largest mobile phone company, M-Pesa is based around the transfer of cash from one user of the scheme to another, anywhere in the country. Suppose, for example, John Obama has moved from his village near Kisumu to work as a taxi driver in Nairobi, and wishes to send money back to his mother at month-end. Before M-Pesa, he would have had to use a money order from the post office, or an informal channel such as a bus driver, or taken the money himself - all of which are expensive, risky or time consuming. Now he can use M-Pesa to send money back to his relatives, cheaply, safely and conveniently. After registering for the service, he simply pays the cash to an M-Pesa agent in the city, specifies who the money is to be sent to, and the system sends an sms the recipient, who then goes to another M-Pesa agent, enters a PIN number, and collects the money.

M-Pesa has spread like wildfire in Kenya since its introduction in 2007, and now has as an estimated 9 million users, and 14 000 agents countrywide. That is, an estimated 50% of Kenyan adults make use of the service. It has spread beyond its original remittance function, and now incorporates a payments facility (which is technologically very similar to the remittance function). So John Obama not only uses M-Pesa to send money to his mother on the shores of Lake Victoria, he also lets his customers pay for their taxi fares by M-Pesa - which saves him the bother and risk of handling cash - and as well uses it to pay for his vehicle service and repairs and to buy his groceries. If he has money left at the end of the month, he leaves it on his phone, as it is safer than keeping cash under his mattress. Many people use M-Pesa for paying their utilities bills, so much so that apparently the payments halls of the electricity and water companies have now been emptied of customers, and employers are starting use M-Pesa to pay their workers, rather than using cash. M-Pesa has just started a cross-border service, with remittances enabled between Kenya and the UK.

M-Pesa has spread quickly because it is incredibly useful, saving users time and money. Research by Safaricom indicates an average transaction saves 3 hours in time and 3 dollars in costs. With an estimated half a million transactions daily, these savings add up to large enough numbers to have a macroeconomic impact, leading to considerable efficiency gains and productivity improvements. In agriculture, for example, the labour shortages that often emerge at harvest time are exacerbated when workers take time off at the end of the month to send money home, and similarly teachers in remote locations would have to take a day or more off at month end to take their salary cheque to a bank for encashment.

There are some factors specific to Kenya that have made M-Pesa a roaring success. First, there is a great need - the majority of adults (around 80%) are unbanked and did not previously have access to formal financial services. Second, Kenya has a high level of rural-urban migration, and hence a high level of remittances, mostly between extended family members. Third, it has a high level of mobile phone penetration. It also has a mobile phone company that was prepared to take a risk and make a considerable investment in software, security and an agent network.

But Safaricom was also helped by an accommodating stance taken by the regulator, the Central Bank of Kenya. The CBK recognised that the main regulatory issues were payments related - hence the focus was on consumer protection, security, reliability, and the integrity of the system and the agent network. One of the most important requirements was that all M-Pesa balances on the system had to be backed by money in a “trust account” at a licensed bank, thus providing security for customer funds. Crucially, however, the CBK recognised that this was not a banking service in the usual sense of the word - deposit taking - and hence did not have to be operated by a bank - leaving the way for the mobile network operator (MNO) to implement it. This enabled rapid innovation to be rolled out, and costs to be kept low. This in turn encouraged the growth of high volume low value transactions - in contrast to the normal high value low volume transactions favoured by banks.

M-Pesa-type systems have been rolled out in other countries, and have proved particularly adaptable even where infrastructure is limited - in Afghanistan and Sierra Leone for instance. The approach of the regulator is of crucial importance. Not all have been like the CBK - some have insisted that only banks can operate such systems, but this can stifle the business. The characteristics of the product are more suited to mobile operators than banks, and around the world innovation is generally being driven by the MNOs and technology companies rather than the banks.

As M-Pesa has demonstrated, mobile money has tremendous potential to provide cheap financial services to the unbanked. It may not work everywhere, but policymakers and regulators can assist by taking an appropriate regulatory approach - commensurate with the level of risks involved, but not stifling innovation. As the CBK points out, M-Pesa may involve large numbers of transactions, but the values, even in aggregate, are relatively small. The regulatory task is therefore to protect consumers of the service, rather than to worry about its impact on the banking system. As for the banks in Kenya, they ignored M-Pesa initially, and only woke up when it was too late, and realised that they had lost potential business to a dynamic new competitor.

Structural Economic Change and the Budget Challenge

It is well known that the global financial and economic crisis that erupted in the second half of 2008 has had a dramatic impact on Botswana’s government finances. The collapse in diamond exports in late 2008 and early 2009 sharply reduced government revenues from the mining sector. This was compounded by reduced receipts from the second most important revenue source, the Southern African Customs Union (SACU), as trade volumes fell. Combined with increased government spending – largely planned before the crisis but maintained in the face of reduced revenues to produce a fiscal stimulus to the economy – the result was a budget deficit projected at 15% of GDP in 2009/10.

Like many countries, Botswana faces the challenge of balancing fiscal objectives: maintaining a sufficient fiscal stimulus to support economic activity in the face of global weakness, while not running up excessive debt that could cause a long-term sustainability problem.

However, it is not just a question of waiting for the world economy to recover, and expecting that everything will be back to normal. For instance, in the recently released budget figures for 2010/11, mineral revenues are projected to continue falling, even though diamond production and exports are expected to recover.

In Botswana’s case the fiscal problem is compounded by adverse long-term revenue trends. Before the global crisis, diamond production had more or less reached a peak, with a steady decline in output projected between 2020 and 2030. Although this decline has now been pushed out by a few years, due to the combined effect of the global crisis (and reduced production) and ongoing investment to extend the life of the Jwaneng mine, the eventual challenge of declining mineral revenues has not disappeared.

Hence the emphasis on diversifying the economy and government revenue sources. While these are important objectives and should continue to be pursued, they will not solve the long-term fiscal challenge even if they are successful. The reason for this is simple: diamond mining is extremely profitable, and those profits are taxed at an extremely high rate. Hence, government revenues account for a very high proportion of the value of output. As the economy diversifies, the importance of diamond production diminishes, and it is replaced by other economic activities that are neither as profitable nor can be taxed so highly. The average tax rate will therefore fall, and so will government revenues as a share of GDP.

This can be illustrated by a simple example. Suppose that profit in Botswana’s large, low cost diamond mines accounts for 80 percent of revenues. Suppose also that government’s share of those profits (derived from production royalties, profits taxes and dividends from its half share in Debswana), amount to around 80 percent of profits. Government revenues would then account for around 65 percent of the value of the industry’s gross output.

Consider what happens as the economy diversifies, and other industries – whether agriculture, mining, manufacturing or services – grow as diamond production declines. While rates of profit vary from industry to industry, an average rate of profit might be, say, 25 percent of revenues – far below that in diamond mining. And a more normal tax rate would be 25 percent of those profits – again, far below the effective tax rate on Debswana. The outcome in this example is dramatic – government revenues would only account for around 6 percent of the value of gross output, barely one-tenth of the revenues raised from the same value of output produced by Debswana.

The above is an illustrative example, but the numbers are probably not far from reality. And the conclusion is clear: even if the economy successfully diversifies, government revenues will decline as a share of GDP (which is the most relevant measure).

Historically, government has based its budget around an expectation that revenues will be equivalent to around 40 percent of GDP – this was the basis of the Fiscal Rule presented in the mid-term review of NDP 10, which limited spending to 40 percent of GDP on average.

Going forward, the Fiscal Rule needs to be drastically revised. In 2010/11, revenues are expected to be only 27 percent of GDP. This may seem low, but it is typical of middle-income developing countries. Elsewhere in SADC, for instance, government revenues amount to some 25 percent of GDP in South Africa and only 20 percent in Mauritius, both countries with similar levels of income per capita as Botswana.

In the medium to long term, the maximum sustainable level of government spending in Botswana is probably around 30 percent of GDP. Relative to the NDP 9 Fiscal Rule, or to projected spending in 2010/11, this means that Government spending has to shrink by around one-quarter, relative to the size of the economy. Hence the emphasis on “Transformation” in the 2010 Budget Speech – government spending has to become much more efficient, and much more focused on priorities.

Open Skies

A couple of weeks back I went on a trip to West Africa that involved, amongst others, the following flights: Johannesburg to Accra, Ghana on Air Namibia; Accra to Monrovia, Liberia on Kenya Airways; and Monrovia back to Accra on Ethiopian Airways. What makes this interesting? The point is that all of those flights were on airlines from countries that were neither the start nor end point of the journey. This is an example of the “fifth freedom” of the air, whereby an airline starts a journey in its own country, proceeds to a second country, and can then pick up passengers and proceed to a third country, and vice versa. South Africa, Ghana and Liberia subscribe to this “fifth freedom”, one of the key components of an “open skies” policy with regard to air travel. What is the result? Well, for Ghana, the outcome is that Accra is a bustling air transport hub for West Africa, with flights to many regional and international destinations operated by a range of airlines, almost all of which are not based in Ghana.

What about Botswana? Unfortunately we don’t grant fifth freedom rights, even though under the Yamoussoukro Declaration, African countries are in principle committed to such open skies liberalisation. So, for example, the Kenya Airways flight from Nairobi to Harare and Gaborone cannot transport passengers between Harare and Gaborone. Apparently this has been blocked by Air Botswana who consider Gaborone-Harare to be one of “their” routes. The result: fewer air transport connections for Botswana.

Wouldn’t the granting of such fifth freedom rights help to establish Botswana as a regional air transport hub, as has been cited as a government policy objective? Of course it would. I am reliably informed that KQ has offered to operate a flight on the Gaborone-Lusaka-Nairobi route, on condition that they have traffic rights between Gaborone and Lusaka. Again, blocked by Air Botswana. Result: no direct flights between Botswana and Zambia.

Open skies liberalisation of air transport in the European Union was one of the main factors behind the dramatic growth and falling cost of air travel in Europe. Extensive evidence shows that when air travel is liberalised, inefficient state-owned airlines may suffer from increased competition, but the overall benefits – from, say, lower air fares and increased jobs in the tourism industry – far outweigh any losses. It is time for Botswana to take the plunge and fully liberalise air travel, and not let narrow vested interests block policy reform that is in the overall national interest.