Domestic credit and balance of payment in Tanzania

In the Structural Adjustment Programme (SAP) 1982, Tanzania set increased foreign exchange receipts as one of its major goals for rehabilitation of the economy. This goal entails a reduction in the country's trade deficits and the maintenance of some amount of stability in the balance of payments. The records up to 1981 however show that past payments policies adopted with this aim in mind have not had the requisite effect on the foreign sector. To ensure that the 1982 SAP target is met, therefore, reasons for past policy failures must first be identified and measures taken to counter them. The starting point for such an enquiry should be a comprehensive analysis of Tanzanian balance of payments adjustments, their causes and effects. The novelty of such an analysis would be its inclusion of both monetary and real variables in its study. Most earlier studies of the Tanzanian balance of payments and external sector have tended to concentrate their analysis on real sector changes. Studies by Yaffey (1970), Green, Rwegasira and Van Arkadie (1980), and Hanak (1982) for example, give little or no emphasis to the link between the monetary sector and the country's external account. On the other hand, monetarists such as Johnson (1976) and Frenkel (1978) argue that monetary variables are the key element in balance of payments adjustments. A synthesis of these two main views (real sector and monetary) on how payments imbalances arise might possibly shed more light on the processes generating these imbalances. It could also highlight faults in either of the two approaches which have led to the application of deficient policy measures in the country. As a first step on the road to such a comprehensive study this research sets out to test for the applicability of the monetary approach to the balance of payments in Tanzania. Specifically it tested for the existence of any substantial link between domestic credit expansions and balance of payments deficits incurred by the country. At the same time an attempt was made to improve on the monetary model of payments adjustments by incorporating real variables in the empirical analysis. Data on the balance of payments, money supply and other macroeconomic variables was collected for the period 1968 to 1981. Both qualitative and quantitative methods of analysing the data were then employed. The qualitative study involved a brief survey of developments in the monetary sector and the balance of payments of the country during the 1970s. The quantitative analysis employed econometric methods in which Ordinary Least Squares techniques were used. In this econometric analysis it was found that credit expansions in the country are negatively linked to the balance of payments as hypothesised. In one of the regressed equations the credit variable was also found to be a significant contributor to changes in the net foreign assets position of the country. In the same equation it was found that incorporation of real variables improved the estimates. The main policy implications drawn from the above results were two-fold. Firstly, the central authorities concerned should try to maintain balance between the money supply and demand in the country. This may be achieved through reductions in government bank borrowing and adherence to the credit limits set in the country's Finance and Credit Plans. This aim could also more preferably be achieved through increased capacity utilization in the country so that real output and money demand are increased. Secondly, the authorities should try to formulate comprehensive payments policies to deal with adverse developments in both the real and monetary sectors of the economy affecting the external account. The basis for such policies could be the comprehensive study already suggested.