Variation and Impact of Interest Rate in Commercial Banks in Tajikistan after Accession to WTO

An investigation of variation and
impact of interest rate in
commercial banks in Tajikistan
after accession to WTO

CHAPTER 1 - INTRODUCTION
1.0 Introduction
Financial liberalisation is essential for the financial activities of the organisation. Thus, it is very
essential to understand the significance and scope of the interest rate variations. The introduction chapter
provides the background and rationale of the study so that relevant aims and objectives can be developed.
It also describes research hypotheses and brief analysis of research methodology which is used for
conducting the research.
1.1 Research Background
Financial liberalisation should be understood as the removal of restrictions in the activities of banks and
other financial organisations in the provision of financial services, for example, in the provision of loans,
deposit registration, etc. This enables the financial institutions to decide independently on whom and by
what criteria to allocate loans, allows them to set the price (interest rate) for loans and interests on received
deposits, and determine where to (aside from lending) to allocate the funds at their disposal (Bogdan &
Biklen, 2003). There is a close connection between financial liberalisation and the banking crisis, which
deserves close attention.
In the 1990s, beneath the impact of economic complications a number of countries started fundamental
changes in monetary policy, institutional structure and overall performance of the economy as well as in
ways to accomplish the goals (Harrod, 2008). Due to the gradual economic backlog, many countries in Latin
America and Asia, as well as countries with centralised planning, relatively quickly abandoned government
intervention in the economy and liberalised economic activity.
The process of liberalisation also spread to the financial sector, and first of all to banks that for a long time
belonged to the most regulated spheres of entrepreneurship, not only in developing countries but also in
many developed countries. Furthermost specialists settle that financial liberalisation in itself is a progressive
change since it allows you to direct the investments to the place where they can be used most effectively.
Thus, liberalisation helps to accelerate economic progression (Sneider & Larner, 2009). Nevertheless, the
knowledge of numerous countries illustrates that under certain circumstances it can produce a growth in
rates and risks for some period of time.

Financial liberalisation significantly changes the environment in which banks and other financial institutions
operate. With liberalisation, there is a risk of a disruption in the normal operation of the banking sector due
to a combination of the consequences of banks' behaviour in a regulated environment accumulated but not
solved problems and incentives acting in a new liberal environment (Ponterotto, 2005). The environment,
previously protected from external influences, together with strict regulation of financial and credit
activities, contributed to the development of negative phenomena in the work of banks.
In general, this means that decisions to place assets were made without taking into account the market
criteria for maximising profits. Often banks provided loans on the basis of political requirements or
subjective desire of owners, sometimes simultaneously acting as customers of banking services. In such a
situation, the banks were not formed, and the skills necessary for successful functioning in an unprotected
and poorly regulated environment created as a result of financial liberalisation could not be formed. The
previous practice of granting loans created a threat of decreasing the quality of the loan portfolio and, at
the same time, did not allow bankers to monitor debtors promptly and assess the degree of risk in lending
(Harrod, 2008).
Usually financial liberalisation is conceded out within the framework of the global approach of
macroeconomic balance, financial liberalisation and structural modifications (Senhadji, 2000). As a result of
overall liberalisation the economic situation of many enterprises deteriorates and the total of resources
used to repay bank loans is reduced.
In the course of reforms and the implementation of stabilisation plans which are often related with financial
liberalisation banks change the way monetary policy is implemented. These policy changes significantly
affect the rate of interest change. Also, the role of direct delivery of credits among banks decreases and the
meaning of indirect tools of influence on fluidity in the economy such as operations in the open money
market, accounting of bills increases. Thus, in order to achieve the profitable targets banks often varies
interest rate. In the progression of macroeconomic stabilisation further restrictions on economic policy are
also introduced (Berg and Krueger, 2002). These modifications in turn decrease the possibility for banks to
appeal other resources, such as primarily loans from the central bank and short term financial resources
purchased in e-market. The costs of obtaining these assets are increasing. These factors are primarily

associated with the changing interest rates and thus influences the profits and financing functions of the
economy.
Companies that previously relied on subsidies from the provincial and local government of Tajikistan
budget are regularly deprived of this important cause of financing.
At the same time situation is complicated by the fact that debtor companies themselves are feeling the
needs of limiting economic and financial policies. As an outcome, the liquidity crisis can provoke a wave of
non-payments, as debtors lose the ability to fulfil their obligations.
A side effect of successful stabilisation programs is a high level of market interest rates, which is established,
in particular, due to the accelerated inflation rate as compared to the expected decrease, as well as the
appreciation of the exchange rate. In the latter case, the situation of enterprises that produce goods
destined for export deteriorates, as their competitiveness in the world market falls. Exporting enterprises in
Tajikistan are forced to adjust to the new condition increase efficiency, sales growth of products inside the
country. Else, they can face financial problems, which rises the risk for banks lending to these enterprises.
The interest rate has been one of the critical factor in encouraging the liberalisation process within
financial sector. When interest rates are increased it leads to increase refinancing rate and thus banks have
to pay higher cost to manage their resources. This has an adverse impact on the position ability of
customers who desired to pay the loans. The increased interest rates also affect debtors in negative
manner. When such situations occurs in Tajikistan then, investment projects promising high income despite
increasing interest rates resort to commercial banks.
Negative impact due to fluctuating economic policies and refinancing rate in Tajikistan is changing the value
of interest rates reliant on the loan reimbursement stage. In the course of liberalisation, the differentiation
among the interest rates short term and long term loans which is of great meaning for banks usually
decreases. In Tajikistan interest rates are differentiated on the basis of loan terms. Hence, commercial
banks of the country are able to generate profits by transferring short-term liabilities (deposits) to long-term
assets (loans)

. Interest on deposits mainly short-term through administrative limits was set at a much lower level than
interest rates on loans granted which usually issued for a long period. In a number of countries such as UK
and USA as a result of interest rate liberalisation, the possibility of easy profit-making in this way has
diminished, as the cost of seeking financial resources has increased and it has suited more problematic to
establish high interest rates for the use of credit.
Banks are difficult to resist the negative impact of changes in the structure of interest rates. Typically, bank
liabilities are sufficiently liquid, because they represent deposits that are not limited to a certain period, and
banks can quickly lose them. In contrast, assets have significantly less liquidity. Credit obligations of
borrowers, as a rule, can be sold to other entities only with large losses. The severance of contractual credit
relations, in turn, is associated with additional costs in the form of penalties.
Financial liberalisation leads to increased competition between the banks. Therefore, they are forced to
both reduce the cost of finding resources, and to resist competitors in their use. As a result, the profit
decreases.
As a result of liberalisation, the liabilities of commercial banks are affected by competition from other
financial institutions domestic and foreign that have access to the banking market. The situation of banks is
complicated by the fact that enterprises themselves can quickly inform about their financial situation, which
allows them to directly establish links with the owners of financial resources without resorting to the help of
banks. As a rule, enterprises that are able to seek non-bank financing sources are the best customers and
their loss means for banks increasing the level of credit portfolio risk.
1.2 Research Problem
For a long time, developing countries were the subject of much debate surrounding the most efficient steps
that they could take to economic prosperity. Many vigorous debates on the subject ensued; however, a
main argument surfaced namely the Washington consensus. This consensus was a set of ten policy
prescriptions meant for crisis ridden developing nations, where the fourth point was interest rate
liberalisation. The key themes emerged from the consensus macroeconomic discipline, a market economy,

and openness to the world (Williamson, 2002). On formulating a market economy, various reforms were
important in this regard. But it is important to note that, liberalisation of interest rates was a key policy
prescription. The positive effects of financial liberalisation are almost a stylised fact in the economics
literature. However, Chaudry (2006) notes the difficulty of measuring financial liberalisation. The task is
simplified with the suggestion that financial liberalisation of the financial sector leads to financial
development and then to economic growth (McKinnon and Shaw, 1973).
1.3 Aim& Objectives of the Research
Aim
The impact of the variation of interest rate in commercial banks in Tajikistan after accession to the WTO.
Objectives
1. To study the current condition of interest rate in commercial banks in Tajikistan.
2. To examine with theory, models and analysis in order to investigate the fluctuation of interest rate.
3. To analyse the impact of interest rate liberalisation in the financial system of Tajikistan.
4 To compare the interest rate liberalisation of Tajikistan with the neighbourhood countries. ffective. In
addition, any combination of a market portfolio with a risk-free asset also provides an efficient portfolio
with less risk and less expected income. This approach is macroeconomic, since in it the main object of
study is the distribution of aggregate capital in the economy into 2 forms: cash and non-cash (in the form of
securities). The next difference between the Markowits and Tobin theory is that Markowits emphasised the
mathematical analysis of the consequences of the initial data and the development of algorithms for solving
optimisation problems. Tobin also took as a basis the analysis of the factors that compel investors to form a
portfolio of securities rather than keep them in one form.
The Research Questions

1. What is the ongoing concern regarding interest rate on the commercial banks in Tajikistan?
2. What are the relative factors behind the cause of fluctuation of interest rate?
3. How does the interest rate liberalisation impact on its financial system?
4. What are the recommendations to guide the banks on achieving interest rate stability.
Research Hypothesis
This study supposes that the interest rate liberalisation does have positive impact on the performance of
the banking sector of Tajikistan.
1.4 Justification for the Research
Financial sectors of developing countries characterised by local financial institutions with deficient
prudential regulations and supervision, where interest rate levels were put in place governmentally;
uncompetitive and segmented financial markets with a small number of large commercial banks dominating
the sector (Chaudry, 2006). Furthermore, the presence of informal financing and segmented fiscal
organisations in terms of actions and economic areas, sources of finance for organisations and prescribed
form of assets to hold. In these procedures the national bank usually has limited governor on the area and
generally exists for the servicing of government debts, conducting foreign exchange transactions on behalf
of government and ensuring that organisations do not enter into liquescency complications. Due to these
factors then, developing countries' financial systems were said to be financially repressed (Kabubo and
Ngugi, 1998). The term financial repression was created by McKinnon and Shaw (1973), in which the above
situation represented extreme financial repression. Based on McKinnon and Shaw (1973) that proposes that
repressed financial system hinders economic development as the intermediaries are not adequately
developed for mobilisation of savings. While the allocation of financial resources among competing uses is
inefficient. According to McKinnon and Shaw (1973) framework proffers policy prescription to effectively
deal with the adverse effects of financial repression. This prescription hinges mainly on interest rate
liberalisation i.e. market determined interest rates. It is believed that due to financial repression, interest
rates would be at sub optimal levels thus causing the need for credit rationing (Serieux, 2008). The removal
of interest rate controls is predicted to increase the interest rate which makes saving attractive,

consequently domestic savings increase. Since there is now more savings, the domestic intermediaries are
able to offer loans competitively, thus investment increases and with this ultimately economic growth
(McKinnon and Shaw, 1973). However, financial liberalisation includes more than interest rate reformation
(Williamson, 2002). The lynchpin of which, is market determined interest rates that effectively and
accurately price financial assets and reveal their risk, maturity as well as costs. The other elements of
financial liberalisation include fostering competition among participants in the financial sector, improving
prudential regulations and supervision, reducing market fragmentation and adoption of indirect instruments
of monetary control.
1.5 Brief Description of the Research Methodology
Theoretical and empirical literature on the real sector, finance sector and McKinnon and Shaw hypothesis is
surveyed with a view to buttress understanding of the empirical results to be obtained. The second step
includes the compilation of selected data pertinent to the study. Also, this time period encompasses the
pre-reform era which signifies financial repression, and includes post reform era that is indicative of
financial liberalisation. Prior to applying formal econometric methodology, it is important to ascertain the
behaviour of the data through the use of descriptive statistical tests and simple correlation. Some of the
statistical tests include the mean, variance, standard deviation, skewness, kurtosis and normality of the
data. The study sets out to examine the degree to which theoretical underpinnings of the McKinnon and
Shaw framework manifest in the economy and further to examine the contribution of financial liberalisation
to economic growth. The empirical undertaking to validate this assertion will include cointegration analysis
using the Johansen (1988) and Johansen and Juselius (1990) approach. Cointegration allows analysis into
the existence of a long run stable relationship between various pertinent variables such as financial
development proxies, financial liberalisation proxies, interest rate, savings, growth and investment.
However, preceding that principal component analysis is used to obtain an index for financial liberalisation
as in Chowdhury and Shrestha (2006), Fowewe (2005), Loots (2002). Since financial liberalisation is a gradual
process, there are various legislative processes that warrant financial liberalisation that may occur at
different times (Fowewe, 2005). Thus through principal component analysis, it is possible to identify a single
most important component factor that can serve as a proxy for financial liberalisation and financial
development (Ang and Mckibbin, 2007). Therefore, to generate the financial liberalisation index, the study
follows Fowewe (2005) and uses a combination of variables from Fowewe (2005) and Loots (2002) that are
relevant to internal financial liberalisation.