## 1. The Financial Institutions Law (FIL)

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---

### A. Context and reform priorities
- Fund advice since 2012 focused on three macro-critical, closely interlinked reforms:
  - Liberalizing the foreign currency system and developing the formal foreign currency market.
  - Revamping the Central Bank of Myanmar’s (CBM) monetary policy and operations.
  - Strengthening financial sector oversight and the banking sector.
- Rationale for the three legs:
  - Foreign currency reform was essential to reintegrate Myanmar into global trade and financial systems and meet ASEAN commitments; pre-reform official exchange rates were overvalued and suppressed trade and investment.
  - Effective monetary policy required market-based tools, reserve money control, sterilization of FX interventions, response to inflation pass-through, and facilitation of market-determined interest rates; sequencing of interest rate liberalization was emphasized.
  - Banking sector reform was required because the CBM had been part of the Ministry of Finance; four state-owned banks dominated and conducted quasi-fiscal operations; private banks’ lending and deposit rates remained administratively controlled and lending was confined to one-year overdraft loans primarily to large enterprises against a narrow range of collateral.

### B. Key achievements
- Foreign currency market:
  - IMF support helped design and implement a CBM foreign currency auction to develop price discovery and move toward a unified market.
  - CBM foreign currency auctions are currently run daily; chronic rationing and wide market distortions have largely dissipated.
  - A new foreign currency law removed restrictions on current account flows while preserving capital controls.
  - Interbank FX trading was allowed between authorized dealers and a regulatory framework for the interbank FX market was developed.
  - Steps were taken to consolidate government foreign reserves at the CBM to manage the floating regime.
- Monetary policy and domestic financial market development:
  - IMF helped the CBM design and implement a new monetary policy framework targeting reserve money and to develop basic policy instruments and forecasting capacity.
  - Deposit auctions and T-bill auctions have been introduced and take place regularly.
  - In September 2016, the government launched a T-Bond auction.
  - Reserve requirements have been reformulated and recently started to be enforced.
  - Existing paper-based government bonds were de-materialized and transformed into standardized tranches with maturities to November 2020.
  - In principle the CBM now has a set of basic instruments and procedures to conduct effective monetary policy, including deposit auctions and procedures to conduct credit auctions (credit auctions have not yet been used given liquidity).
- Strengthening the banking sector:
  - New legislation established an autonomous CBM with clearer authority for licensing, supervision and regulation of banks, and monetary policy, aligned with a mandate for price and financial stability.
  - With World Bank and IMF technical assistance, a new Financial Institutions Law (FIL) was adopted in 2016 and a set of core prudential regulations prepared and some issued.
  - Significant progress in bank supervision, including near completion of full-scope examinations of the commercial banks and one state-owned bank.

### C. The Financial Institutions Law (FIL) — salient provisions
- The law brings Myanmar’s legal and regulatory framework closer to international good standards and, amongst other reforms:
  - Installs a comprehensive legal and regulatory framework for the implementation of the Basle Core Principles;
  - Introduces sufficient powers to supervise licensed institutions, impose prudential regulations, governance requirements and accounting and auditing standards on these institutions and provides an adequate framework for licensing and regulation of foreign banks;
  - Removes the anomaly of granting two licenses—commercial bank and development bank licenses—to the same entity—and broadens the permissible activities of the bank in line with international practices;
  - Levels the playing field between private and state owned banks (except in the case of large exposure and removal of officers and directors);
  - Establishes a framework for prompt corrective action and bank resolution;
  - Establishes clear rules on bank insolvency, provides for voluntary and involuntary liquidation, reorders the priority of payment favoring depositors, and for cross border insolvency;
  - Provides adequate provisions to deal with consumer protection, internet and mobile banking and e-money;
  - Establishes a framework to oversee nonbank financial institutions and powers to ensure that they do not carry out shadow banking;
  - Enables the regulation of the payment system, electronic evidence, electronic presentment of checks and admissibility of electronic evidence, and includes provision for the recognition of netting agreements, finality of settlement and the enforceability of settlement rules for systems designated by the CBM.

### D. Remaining challenges and risks
- Foreign currency market fragmentation and CBM interventions:
  - Occasional large divergences between formal and informal market rates occurred (e.g., late 2014 to mid-July 2015).
  - The CBM has at times attempted to slow kyat depreciation and departed from auction rules, leading to the reference rate being misaligned with informal rates by more than the 0.8 percent allowed by the CBM.
  - Misalignment has legally locked authorized dealers out of the FX market at times; a unified interbank-centered FX market remains an aspiration.
- FX reserve buffers and external position:
  - CBM has struggled to build FX reserve buffers due to a rising current account deficit and pressures from exogenous shocks (decline in natural gas price, lower agricultural exports due to floods), uncertainty around November 2015 elections, and ongoing monetary financing of fiscal deficits (including a sharp increase in FY 2015/16).
  - State-owned banks have been unable to transfer foreign reserves of the state to the CBM after initial 2013 efforts.
  - Anticipated capital inflows and resource booms have not materialized; the external position has been weaker than expected.
- Government financing and T-bill market:
  - Treasury bills are not being issued in sufficient volume to finance the government; the government remains heavily reliant upon monetary financing from the CBM.
  - The Ministry of Planning and Finance (MoPF) has seemed reluctant to pay the T-bill rates required to induce larger purchases by banks, despite recent efforts to allocate more budgetary resources for interest expenses.
- Inflation, monetary policy implementation, and financial repression:
  - Inflation rose significantly in part due to slow and ineffective deployment of available policy instruments (slow implementation of recalibrated reserve requirements, insufficient deposit auctions to mop up excess liquidity, and absence of a monetary policy committee), pushing real interest rates into negative territory and exacerbating financial repression.
  - Negative real rates have severely restrained credit available to SMEs and the agricultural sector and increased losses of state-owned banks providing subsidized loans.
- Regulatory and supervisory capacity:
  - Rapid entry of foreign banks and rapid expansion of domestic private banks have outpaced the introduction and enforcement of prudential regulations and CBM supervisory capacity.
- Capitalization and systemic vulnerabilities:
  - The Myanmar banking sector is undercapitalized relative to risks faced (concentration and interrelated lending risks, weak accounting and auditing practices, need to strengthen prudential supervision and regulation).
  - Myanmar’s vulnerability to shocks (including weather-related natural disasters) and high country risk call for higher capital buffers.
- State-owned banks:
  - State-owned banks, while losing market share to private banks, still accounted for half of financial sector total assets in August 2015.
  - Diagnostic analyses of some state-owned banks have been conducted with World Bank assistance, but reform plans to improve governance, financial reporting, risk management, and to reduce contingent fiscal risk have yet to be formulated.

### E. Interaction of risks and implications for reform
- Continued monetary financing of fiscal deficits risks entrenching inflation expectations, exacerbating the external current account deficit, and placing downward pressure on the kyat.
- Continued high inflation would erode banks’ profitability and prudential buffers given interest rate controls; continued kyat depreciation would amplify financial risks from currency mismatch.
- Containing these mutually reinforcing risks is a key objective in reforming Myanmar’s financial sector.

*Source: IMF staff report "Myanmar’s Financial Sector: Strategy and Priorities for Reform" (December 29, 2016).*

---

### Financial Inclusion in Myanmar (Box 2)

### Financial sector overview and inclusion indicators
- Myanmar’s financial sector is still in the early stages of development compared to countries in the region.
- Access to basic financial services is extremely limited as measured by:
  - Only about 6 percent of commercial bank loans going to the rural sector.
  - 62.7 percent of the population do not report any savings.
  - 25.7 percent save at home or with someone they know.
  - Deposits were 35 percent of GDP in 2015/16.
  - Domestic credit was 38 percent of GDP in 2015/16.
  - Credit to the private sector was 19 percent of GDP in 2015/16.
  - Myanmar has only 3.3 commercial bank branches per 100,000 inhabitants in 2015.
  - Over 75 percent of adults do not have a bank account in a financial institution.
- State-owned banks (SOBs) still account for around a half of banking sector assets and a majority of bank branches and customers nationwide.
  - Private banks have a market share of 64 percent in banking deposits, and 82 percent in banking loans.
- A large share of available credit is destined for the public sector:
  - In 2015/16, 49 percent of domestic credit went to the government, of which 80 percent came from the CBM.
- Agriculture and rural finance:
  - The agricultural sector represents 30 percent of GDP and employs 54 percent of the population, yet only about 2.5 percent of all outstanding loans are made to this sector.
  - Myanma Agricultural Development Bank (MADB) accounts for 1.3 percent of total assets in the banking system.
  - It is estimated that more than 3.5 million farmers are not served by MADB due to lack of land titles (World Bank, 2014).
- Microfinance and infrastructure constraints:
  - Rural microfinance and cooperatives have limited reach and product offerings.
  - Until recently, MFIs were not allowed to borrow domestically from banks; foreign borrowing could not incur interest rates of more than 8 percent.
  - Bank lending rates capped at 13 percent have reduced incentives for banks to lend to MFIs.
  - Myanmar ranks 134th out of 140 countries in terms of infrastructure quality (Global Competitiveness Index 2015–2016).

### Risks and lessons from other countries (Box 3)
- Financial liberalization experiences during the 1980s and 1990s illustrate both benefits and delayed, substantial risks:
  - Greater competition by foreign banks may increase risks taken by domestic banks as profitable domestic corporates gain access to foreign capital.
  - Effective regulation and supervision are crucial as liberalization increases risky competition and new funding sources emerge.
  - Poor supervision, opaque affiliate structures and weak corporate governance can allow weak banks to over-extend and pursue high risk/high return strategies using depositors’ funds.
  - Banks were often over-exposed to well-connected borrowers and under-reported non-performing loans by rolling them over (“ever-greening”).
  - Maturity and currency mismatches arose where bank lending became funded by short-term capital inflows.
  - In unstable macroeconomic situations, rapid interest-rate liberalization sometimes produced high real interest rates, leading to corporate and banking problems.
  - Access to credit expanded less than expected or was imprudently directed due to lack of borrower information and weak legal/judicial systems for collateral and creditor rights.

### Planning next steps and recommended reforms (high-level)
- Next steps towards financial liberalization should be:
  - Carefully sequenced.
  - Built upon sound monetary and fiscal financing policies.
  - Supported by strengthened supervision capacity and oversight of the financial system.
- If these building blocks are missing, Myanmar could risk repeating mistakes other countries made during liberalization.

### Appendix I — Recommended actions and indicative timing (selected items)
(i) Continued reform of the foreign currency system
- CBM to ensure close alignment between the formal and informal exchange rates by consistently enforcing the foreign currency auction rules. — Continuing
- Authorities to effectively prohibit informal foreign currency trading through domestic transfers between accounts at banks. — 1-2 years
- CBM to ensure that banks are well-acquainted with the foreign exchange regulatory framework; CBM to issue the foreign exchange law/regulations and main directives in English. — Immediately
- CBM to ease the restrictions on foreign currency deposit withdrawals. — 1-2 years
- MoPF to audit the state owned banks, including their net FX positions, close any net FX short positions, and put in place a mechanism to transfer new government owned net reserves to the CBM. — Immediately
- MoPF to facilitate settling the account balance transfers between state-owned banks and private and foreign banks’ nostro accounts. — Immediately

(ii) Further strengthen monetary policy and support domestic financial markets
- MoPF progressively to reduce monetary financing from the CBM to zero within two years. — 1-2 years
- CBM to issue revised instruction governing the interbank market, allowing banks to freely set maturities, as needed for liquidity management. — 1-2 years
- CBM to continue to enforce reserve requirements, including penalties for non-compliance. — Immediately
- CBM to prepare and approve its own budget (independent of the MoPF) and scale up deposit auctions and consistently allow the rates to be freely set by the market. — Immediately
- MoPF to continue to issue liquid “benchmark” bonds by auction and ensure market determined interest rates on government treasury bill and bond issues by following auction rules. — 1 year
- MoPF to convert (a portion of) the treasury bills held by the CBM into dematerialized bonds at liquid benchmark points. — 1-2 years
- CBM to apply tiered (higher) lending rate caps on the new loan products allowed under the new regulations. — 1-2 years
- CBM to allow commercial banks to freely repatriate Kyat currency notes to the CBM without charges. — Immediately
- CBM to establish a monetary policy committee to set interest rates and an interdepartmental monetary policy working group. — 1 year
- MoPF to establish a single treasury account at the CBM and migrate the MoPF’s accounts from the Myanmar Economic Bank. — 1-2 years

(iii) Strengthening the banking sector
- CBM to reorganize along functional lines consistent with the 2013 central bank law and implementing regulations. — 1-2 years
- CBM to issue and enforce outstanding new regulations under the FIL (capital adequacy, classification and provisioning, lending to related parties, large exposures, liquidity). — Immediately
- CBM to implement the three-year plan to enhance supervisory capacity (staffing and training), enhance on-site examinations, off-site supervision, and enforcement. — 1-3 years
- CBM to complete full scope examinations of all banks, including state-owned banks covered by the FIL. — 1 year
- CBM to issue no new licenses for private banks until supervisory resources are significantly strengthened; CBM to cease licensing new policy banks. — Immediately
- CBM to identify and audit weak banks and require capital and liquidity recovery plans; apply recovery measures (including suspending dividend payments) at non-compliant banks. — 1 year
- CBM to develop and implement more stringent capital requirements aligned with enhanced international standards, e.g., a minimum of 6 percent tier 1 capital and 12 percent total capital. — 1-2 years
- CBM to develop a report format for reporting a risk-based CAMEL rating system, and implement.
- CBM to develop contingency plans for resolving banks, and implement reforms to enhance recovery and resolution planning and preparedness. — 1 year
- CBM to develop and implement enhanced arrangements to provide emergency liquidity support to solvent banks on a collateralized basis, subject to adequate safeguards. — 2 years
- CBM to review and approve banks’ credit risk management policies and procedures. — 1 year

---

### DSGE Model, Calibration, Reform Scenarios, and Key Quantitative Results

### Model overview and calibration
- Model type: Dynamic Stochastic General Equilibrium (DSGE) model for a small open economy with multiple sectors and multiple types of heterogeneous households.
- Money demand introduced through a cash-in-advance constraint.
- A fraction of total savings finances government and SOE operations; the remainder finances private credit.
- Household heterogeneity: urban and rural households differ in occupations and access to financial intermediaries; within-sector heterogeneity arises from household-specific productivity shocks.
- Calibration reproduces Gini index relatively low (0.29) and about 38 percent of the population lives in poverty.
- Households face income shocks calibrated to reproduce observed distributional statistics.

### Reform scenarios considered
- Financial liberalization:
  - Gradual liberalization of interest rates by allowing the deposit rate to rise by 1 percentage point and reducing the growth of money supply sufficiently to lower inflation by 2 percentage points.
  - Results in an increase in the real deposit rate and makes more financial resources available to the private sector.
- Financial inclusion:
  - Includes financial liberalization measures plus easier access to private credit for a larger fraction of the agricultural sector via exogenous reductions in impediments to credit.
- Higher infrastructure investment (all sectors):
  - Financial inclusion scenario plus channeling higher tax revenues generated by higher growth toward infrastructure investment that improves productivity across all sectors.
- Higher infrastructure investment in agriculture:
  - Financial inclusion scenario plus channeling higher tax revenues toward infrastructure investment that benefits the agricultural sector specifically.

### Illustrative quantitative outcomes (selected)
- Financial liberalization:
  - Industrial sector share of GDP increases by 5.6 percentage points.
  - Total private credit to GDP ratio increases by 2.25 percentage points.
  - GDP growth rate is nearly 2 percentage points above trend.
  - Private investment grows by 5.0  percentage points above trend.
  - Gini coefficient falls by 1.6 points.
  - Poverty rate falls by 5 percentage points.
- Financial inclusion (credit expansion to rural sector):
  - Total private credit to GDP ratio and GDP growth rate are slightly lower than under financial liberalization.
  - Rural agricultural output and farm income increase.
  - National Gini decreases by 1.2 points.
  - Poverty falls by 4.4 percentage points nationwide.
- Infrastructure investment directed to all sectors:
  - Annual GDP growth rate 3.1 percentage points above trend.
  - Annual investment growth 7.4 percentage points above trend.
  - Industrial sector share of GDP 1.6 percentage points larger than in baseline.
  - Reduces Gini coefficient by 1.8 points.
  - Poverty rate falls by 6.5 percentage points.
- Infrastructure investment focused on agriculture:
  - Annual GDP growth rate 2.3 percentage points above trend.
  - Annual investment growth 5.4 percentage points above trend.
  - Industrial sector share of GDP 11.0 percentage points smaller than in baseline.
  - Reduces Gini coefficient by 2.6 points.
  - Poverty rate falls by 6.4 percentage points.

### Policy implications from model results
- Financial liberalization (with supportive macro conditions) can:
  - Boost economic growth, reduce poverty, and improve nationwide income distribution.
  - Allowing increases in interest rates and phasing out CBM financing of fiscal deficits would lead to positive real interest rates, encourage household savings, increase credit supply, raise private investment, and foster growth.
- Financial inclusion policies:
  - Can further reduce poverty but may benefit the poor less unless targeted measures reach disadvantaged groups.
- Infrastructure investment:
  - Amplifies positive impacts on growth and poverty of financial reforms.
  - Trade-offs: rural-targeted infrastructure may yield less aggregate growth but better distributional outcomes.
- Sequencing and trade-offs:
  - Achieving inclusive growth during financial sector reform requires careful sequencing, macro stability (including phasing out central bank financing of fiscal deficits), and targeted policies to protect the poorest.

*IMF staff estimates, model and results as presented in the chapter.*

---

### Disaster Risk, Private Sector Response, and the 2015 Floods in Myanmar

### Disaster risk profile and macro-fiscal effects
- Myanmar exposure:
  - Described as "most-at-risk country in Asia and the Pacific according to the UN Risk Model (OCHA, 2012)" and "second-most affected country worldwide according to the Climate Risk Index (2016)".
- Average Climate-Related Disaster Losses (1970–2015; conditional on an event):
  - Occurrences (annual per thousand square kilometers):
    - Myanmar: 0.0022
    - DAS: 0.0167
    - RoDW (w/o Myanmar): 0.0165
  - Material damage (percent of GDP):
    - Myanmar: 0.5659
    - DAS: 1.2919
    - RoDW (w/o Myanmar): 0.4481
  - People affected (percent of population):
    - Myanmar: 1.0508
    - DAS: 4.2132
    - RoDW (w/o Myanmar): 2.6235
  - People dead (percent of population):
    - Myanmar: 0.0091
    - DAS: 0.0020
    - RoDW (w/o Myanmar): 0.0032
- Severe disaster definition:
  - Events in the 90th percentile of annualized and scaled climate-related material damages across DAS, threshold of material damages: 1.12 percent of GDP.
  - 87 such cases identified; four occurred in Myanmar in 1991, 1992, 2008, and 2015.
- Panel-VARX results (17 DAS countries; severe disasters = top 10 percentile):
  - Immediate mean growth decline of 1.2 percentage points in year t0.
  - Permanent growth loss of 2.2 percentage points over the medium term.
  - Limited dynamic fiscal response on average; large heterogeneity across countries.

### Private sector role in disaster response
- Private sector gross capital formation suggests the private sector plays an important and sometimes preceding role relative to public capital expenditure in disaster response.
- The private sector response is facilitated by the availability of fast and fresh financing.
- Remittances increase immediately after disasters and continue to grow, financing emergency relief and reconstruction; financial and insurance markets remain underdeveloped in DAS.

### The 2015 Floods in Myanmar — impacts and fiscal response
- Event timing: July through September 2015 (cyclone Komen after making landfall in Bangladesh).
- Geographic scope: severe flooding and landslides across 12 of the country’s 14 states and regions.
- Human impact:
  - Killed 171 people.
  - Affected more than 9 million people.
  - Temporarily displaced 1.7 million people (or 17 percent and 3 percent of the population, respectively).
- Economic impact:
  - Total economic impact of US$1.51 billion (or 2.4 percent of GDP).
- Relative severity:
  - This event is in the top 10 percentile of climate-related disasters in DAS over the past four and a half decades on material damages and people affected.
- Macroeconomic and fiscal aftermath:
  - Growth: Relative to the pre-disaster year, growth turned out lower by 0.7 percentage points in FY 2015/16.
  - Fiscal reaction: Revised budget in late 2015 and preliminary FY 2015/16 outcome did not show substantial disaster response in revenues or expenditures.
  - Authorities relied mainly on the Reserve Fund (topped-up to K100 billion since FY 2012/13 but covering less than 1 percent of total estimated damage) and minor reliance on the National Natural Disaster Management Fund (NNDMF).
  - Authorities adhered to preserving the fiscal stance with limited external budget support and limited re-appropriation due to rigid financial rules.

### Policy implications: strengthen ex-ante resilience and ex-post response
- Improve fiscal risk management and public financing assistance:
  - Explicitly integrate climate-related disaster risks into the medium-term fiscal framework and debt sustainability analysis.
  - Build notional fiscal buffers in quiet times; international best practices suggest reserving some 1 percent to 3 percent of spending to fiscal risks.
  - Clarify the role, mandate, governance, budget linkages, and donor relations of the NNDMF.
- Regularize budget process flexibility:
  - Integrate fiscal rules and the Disaster Management Law to allow timely and effective responses, including an escape clause linked to severity classification and streamlined processes for revised budgets.
- Generate fiscal space for mitigation and response:
  - Enhance domestic revenue mobilization and tap newly available international support; improve social safety nets, facilitate access to finance and insurance, and promote disaster-resilient infrastructure (transport, energy, public health, risk-informed spatial planning, building standards, payment systems).
  - Overhaul energy subsidies and taxation, use the opportunity of low fossil fuel prices and the Paris Agreement to eliminate poorly targeted subsidies and introduce carbon taxation, with redistributive flanking measures as needed.
- Strengthen government effectiveness and institutional capacity:
  - Improve coordination and communication across public sector, civil society, donors, and multilateral organizations; enhance planning, information aggregation, policy design and implementation to bolster both public and private disaster responses.

*International Monetary Fund — content unit cr1731, excerpt on the Financial Institutions Law, Financial Inclusion, DSGE model results, and disaster risk including the 2015 floods in Myanmar.*

### 1. The Financial Institutions Law (FIL) ___________________________________________________ 6

### 1. The Financial Institutions Law (FIL)

### A. Context and reform priorities
- Fund advice since 2012 focused on three macro-critical, closely interlinked reforms:
  - Liberalizing the foreign currency system and developing the formal foreign currency market.
  - Revamping the Central Bank of Myanmar’s (CBM) monetary policy and operations.
  - Strengthening financial sector oversight and the banking sector.
- Rationale for the three legs:
  - Foreign currency reform was essential to reintegrate Myanmar into global trade and financial systems and meet ASEAN commitments; pre-reform official exchange rates were overvalued and suppressed trade and investment.
  - Effective monetary policy required market-based tools, reserve money control, sterilization of FX interventions, response to inflation pass-through, and facilitation of market-determined interest rates; sequencing of interest rate liberalization was emphasized.
  - Banking sector reform was required because the CBM had been part of the Ministry of Finance; four state-owned banks dominated and conducted quasi-fiscal operations; private banks’ lending and deposit rates remained administratively controlled and lending was confined to one-year overdraft loans primarily to large enterprises against a narrow range of collateral.

### B. Key achievements
- Foreign currency market:
  - IMF support helped design and implement a CBM foreign currency auction to develop price discovery and move toward a unified market.
  - CBM foreign currency auctions are currently run daily; chronic rationing and wide market distortions have largely dissipated.
  - A new foreign currency law removed restrictions on current account flows while preserving capital controls.
  - Interbank FX trading was allowed between authorized dealers and a regulatory framework for the interbank FX market was developed.
  - Steps were taken to consolidate government foreign reserves at the CBM to manage the floating regime.
- Monetary policy and domestic financial market development:
  - IMF helped the CBM design and implement a new monetary policy framework targeting reserve money and to develop basic policy instruments and forecasting capacity.
  - Deposit auctions and T-bill auctions have been introduced and take place regularly.
  - In September 2016, the government launched a T-Bond auction.
  - Reserve requirements have been reformulated and recently started to be enforced.
  - Existing paper-based government bonds were de-materialized and transformed into standardized tranches with maturities to November 2020.
  - In principle the CBM now has a set of basic instruments and procedures to conduct effective monetary policy, including deposit auctions and procedures to conduct credit auctions (credit auctions have not yet been used given liquidity).
- Strengthening the banking sector:
  - New legislation established an autonomous CBM with clearer authority for licensing, supervision and regulation of banks, and monetary policy, aligned with a mandate for price and financial stability.
  - With World Bank and IMF technical assistance, a new Financial Institutions Law (FIL) was adopted in 2016 and a set of core prudential regulations prepared and some issued.
  - Significant progress in bank supervision, including near completion of full-scope examinations of the commercial banks and one state-owned bank.

### C. The Financial Institutions Law (FIL) — salient provisions
- The law brings Myanmar’s legal and regulatory framework closer to international good standards and, amongst other reforms:
  - Installs a comprehensive legal and regulatory framework for the implementation of the Basle Core Principles;
  - Introduces sufficient powers to supervise licensed institutions, impose prudential regulations, governance requirements and accounting and auditing standards on these institutions and provides an adequate framework for licensing and regulation of foreign banks;
  - Removes the anomaly of granting two licenses—commercial bank and development bank licenses—to the same entity—and broadens the permissible activities of the bank in line with international practices;
  - Levels the playing field between private and state owned banks (except in the case of large exposure and removal of officers and directors);
  - Establishes a framework for prompt corrective action and bank resolution;
  - Establishes clear rules on bank insolvency, provides for voluntary and involuntary liquidation, reorders the priority of payment favoring depositors, and for cross border insolvency;
  - Provides adequate provisions to deal with consumer protection, internet and mobile banking and e-money;
  - Establishes a framework to oversee nonbank financial institutions and powers to ensure that they do not carry out shadow banking;
  - Enables the regulation of the payment system, electronic evidence, electronic presentment of checks and admissibility of electronic evidence, and includes provision for the recognition of netting agreements, finality of settlement and the enforceability of settlement rules for systems designated by the CBM.

### D. Remaining challenges and risks
- Foreign currency market fragmentation and CBM interventions:
  - Occasional large divergences between formal and informal market rates occurred (e.g., late 2014 to mid-July 2015).
  - The CBM has at times attempted to slow kyat depreciation and departed from auction rules, leading to the reference rate being misaligned with informal rates by more than the 0.8 percent allowed by the CBM.
  - Misalignment has legally locked authorized dealers out of the FX market at times; a unified interbank-centered FX market remains an aspiration.
- FX reserve buffers and external position:
  - CBM has struggled to build FX reserve buffers due to a rising current account deficit and pressures from exogenous shocks (decline in natural gas price, lower agricultural exports due to floods), uncertainty around November 2015 elections, and ongoing monetary financing of fiscal deficits (including a sharp increase in FY 2015/16).
  - State-owned banks have been unable to transfer foreign reserves of the state to the CBM after initial 2013 efforts.
  - Anticipated capital inflows and resource booms have not materialized; the external position has been weaker than expected.
- Government financing and T-bill market:
  - Treasury bills are not being issued in sufficient volume to finance the government; the government remains heavily reliant upon monetary financing from the CBM.
  - The Ministry of Planning and Finance (MoPF) has seemed reluctant to pay the T-bill rates required to induce larger purchases by banks, despite recent efforts to allocate more budgetary resources for interest expenses.
- Inflation, monetary policy implementation, and financial repression:
  - Inflation rose significantly in part due to slow and ineffective deployment of available policy instruments (slow implementation of recalibrated reserve requirements, insufficient deposit auctions to mop up excess liquidity, and absence of a monetary policy committee), pushing real interest rates into negative territory and exacerbating financial repression.
  - Negative real rates have severely restrained credit available to SMEs and the agricultural sector and increased losses of state-owned banks providing subsidized loans.
- Regulatory and supervisory capacity:
  - Rapid entry of foreign banks and rapid expansion of domestic private banks have outpaced the introduction and enforcement of prudential regulations and CBM supervisory capacity.
- Capitalization and systemic vulnerabilities:
  - The Myanmar banking sector is undercapitalized relative to risks faced (concentration and interrelated lending risks, weak accounting and auditing practices, need to strengthen prudential supervision and regulation).
  - Myanmar’s vulnerability to shocks (including weather-related natural disasters) and high country risk call for higher capital buffers.
- State-owned banks:
  - State-owned banks, while losing market share to private banks, still accounted for half of financial sector total assets in August 2015.
  - Diagnostic analyses of some state-owned banks have been conducted with World Bank assistance, but reform plans to improve governance, financial reporting, risk management, and to reduce contingent fiscal risk have yet to be formulated.

### E. Interaction of risks and implications for reform
- Continued monetary financing of fiscal deficits risks entrenching inflation expectations, exacerbating the external current account deficit, and placing downward pressure on the kyat.
- Continued high inflation would erode banks’ profitability and prudential buffers given interest rate controls; continued kyat depreciation would amplify financial risks from currency mismatch.
- Containing these mutually reinforcing risks is a key objective in reforming Myanmar’s financial sector.

*Source: IMF staff report "Myanmar’s Financial Sector: Strategy and Priorities for Reform" (December 29, 2016).*

### Box 2. Myanmar: Financial Inclusion in Myanmar

### Box 2. Myanmar: Financial Inclusion in Myanmar

### Financial sector overview and inclusion indicators
- Myanmar’s financial sector is still in the early stages of development compared to countries in the region.
- Access to basic financial services is extremely limited as measured by:
  - Only about 6 percent of commercial bank loans going to the rural sector.
  - 62.7 percent of the population do not report any savings.
  - 25.7 percent save at home or with someone they know.
  - Deposits were 35 percent of GDP in 2015/16.
  - Domestic credit was 38 percent of GDP in 2015/16.
  - Credit to the private sector was 19 percent of GDP in 2015/16.
  - Myanmar has only 3.3 commercial bank branches per 100,000 inhabitants in 2015.
  - Over 75 percent of adults do not have a bank account in a financial institution.
- State-owned banks (SOBs) still account for around a half of banking sector assets and a majority of bank branches and customers nationwide.
  - Private banks have a market share of 64 percent in banking deposits, and 82 percent in banking loans.
- A large share of available credit is destined for the public sector:
  - In 2015/16, 49 percent of domestic credit went to the government, of which 80 percent came from the CBM.
- Agriculture and rural finance:
  - The agricultural sector represents 30 percent of GDP and employs 54 percent of the population, yet only about 2.5 percent of all outstanding loans are made to this sector.
  - Myanma Agricultural Development Bank (MADB) accounts for 1.3 percent of total assets in the banking system.
  - It is estimated that more than 3.5 million farmers are not served by MADB due to lack of land titles (World Bank, 2014).
- Microfinance and infrastructure constraints:
  - Rural microfinance and cooperatives have limited reach and product offerings.
  - Until recently, MFIs were not allowed to borrow domestically from banks; foreign borrowing could not incur interest rates of more than 8 percent.
  - Bank lending rates capped at 13 percent have reduced incentives for banks to lend to MFIs.
  - Myanmar ranks 134th out of 140 countries in terms of infrastructure quality (Global Competitiveness Index 2015–2016).

### Risks and lessons from other countries (Box 3)
- Financial liberalization experiences during the 1980s and 1990s illustrate both benefits and delayed, substantial risks:
  - Greater competition by foreign banks may increase risks taken by domestic banks as profitable domestic corporates gain access to foreign capital.
  - Effective regulation and supervision are crucial as liberalization increases risky competition and new funding sources emerge.
  - Poor supervision, opaque affiliate structures and weak corporate governance can allow weak banks to over-extend and pursue high risk/high return strategies using depositors’ funds.
  - Banks were often over-exposed to well-connected borrowers and under-reported non-performing loans by rolling them over (“ever-greening”).
  - Maturity and currency mismatches arose where bank lending became funded by short-term capital inflows.
  - In unstable macroeconomic situations, rapid interest-rate liberalization sometimes produced high real interest rates, leading to corporate and banking problems.
  - Access to credit expanded less than expected or was imprudently directed due to lack of borrower information and weak legal/judicial systems for collateral and creditor rights.

### Planning next steps and recommended reforms (high-level)
- Next steps towards financial liberalization should be:
  - Carefully sequenced.
  - Built upon sound monetary and fiscal financing policies.
  - Supported by strengthened supervision capacity and oversight of the financial system.
- If these building blocks are missing, Myanmar could risk repeating mistakes other countries made during liberalization.

### Appendix I — Recommended actions and indicative timing (selected items)
(i) Continued reform of the foreign currency system
- CBM to ensure close alignment between the formal and informal exchange rates by consistently enforcing the foreign currency auction rules. — Continuing
- Authorities to effectively prohibit informal foreign currency trading through domestic transfers between accounts at banks. — 1-2 years
- CBM to ensure that banks are well-acquainted with the foreign exchange regulatory framework; CBM to issue the foreign exchange law/regulations and main directives in English. — Immediately
- CBM to ease the restrictions on foreign currency deposit withdrawals. — 1-2 years
- MoPF to audit the state owned banks, including their net FX positions, close any net FX short positions, and put in place a mechanism to transfer new government owned net reserves to the CBM. — Immediately
- MoPF to facilitate settling the account balance transfers between state-owned banks and private and foreign banks’ nostro accounts. — Immediately

(ii) Further strengthen monetary policy and support domestic financial markets
- MoPF progressively to reduce monetary financing from the CBM to zero within two years. — 1-2 years
- CBM to issue revised instruction governing the interbank market, allowing banks to freely set maturities, as needed for liquidity management. — 1-2 years
- CBM to continue to enforce reserve requirements, including penalties for non-compliance. — Immediately
- CBM to prepare and approve its own budget (independent of the MoPF) and scale up deposit auctions and consistently allow the rates to be freely set by the market. — Immediately
- MoPF to continue to issue liquid “benchmark” bonds by auction and ensure market determined interest rates on government treasury bill and bond issues by following auction rules. — 1 year
- MoPF to convert (a portion of) the treasury bills held by the CBM into dematerialized bonds at liquid benchmark points. — 1-2 years
- CBM to apply tiered (higher) lending rate caps on the new loan products allowed under the new regulations. — 1-2 years
- CBM to allow commercial banks to freely repatriate Kyat currency notes to the CBM without charges. — Immediately
- CBM to establish a monetary policy committee to set interest rates and an interdepartmental monetary policy working group. — 1 year
- MoPF to establish a single treasury account at the CBM and migrate the MoPF’s accounts from the Myanmar Economic Bank. — 1-2 years

(iii) Strengthening the banking sector
- CBM to reorganize along functional lines consistent with the 2013 central bank law and implementing regulations. — 1-2 years
- CBM to issue and enforce outstanding new regulations under the FIL (capital adequacy, classification and provisioning, lending to related parties, large exposures, liquidity). — Immediately
- CBM to implement the three-year plan to enhance supervisory capacity (staffing and training), enhance on-site examinations, off-site supervision, and enforcement. — 1-3 years
- CBM to complete full scope examinations of all banks, including state-owned banks covered by the FIL. — 1 year
- CBM to issue no new licenses for private banks until supervisory resources are significantly strengthened; CBM to cease licensing new policy banks. — Immediately
- CBM to identify and audit weak banks and require capital and liquidity recovery plans; apply recovery measures (including suspending dividend payments) at non-compliant banks. — 1 year
- CBM to develop and implement more stringent capital requirements aligned with enhanced international standards, e.g., a minimum of 6 percent tier 1 capital and 12 percent total capital. — 1-2 years
- CBM to develop a report format for reporting a risk-based CAMEL rating system, and implement.
- CBM to develop contingency plans for resolving banks, and implement reforms to enhance recovery and resolution planning and preparedness. — 1 year
- CBM to develop and implement enhanced arrangements to provide emergency liquidity support to solvent banks on a collateralized basis, subject to adequate safeguards. — 2 years
- CBM to review and approve banks’ credit risk management policies and procedures. — 1 year

### Macro and distributional analysis (model context)
- Financial sector reform is being evaluated using a dynamic stochastic general equilibrium (DSGE) model to understand potential impacts on economic growth, poverty, and income distribution.
- The model is highly stylized; quantitative results are illustrative (not predictions) and intended to inform policy design and complementary measures for financial sector reform.

*Source: Box 2. Myanmar: Financial Inclusion in Myanmar*

### 12.      The model developed in this study is a Dynamic Stochastic General Equilibrium (DSGE)

### 12.      The model developed in this study is a Dynamic Stochastic General Equilibrium (DSGE) model

### Model overview
- The model is a Dynamic Stochastic General Equilibrium (DSGE) model for a small open economy with multiple sectors and multiple types of heterogeneous households.
- It reproduces key macroeconomic trends and distributional features of household-level data once calibrated.
- Money demand is introduced through a cash-in-advance constraint (cash required for obtaining consumption goods).
- A fraction of total savings finances government and SOE operations; the remainder finances private credit.
- Private investment and agricultural intermediates (seeds, fertilizer, etc.) constitute total private credit demand.
- Household heterogeneity:
  - Urban and rural households differ in occupations and access to financial intermediaries.
  - Within-sector heterogeneity arises from household-specific productivity shocks.
- Labor mobility across sectors and geographical areas involves a cost calibrated to reproduce observed income differentials between rural and urban households.

### Calibration for Myanmar: salient features matched
- Significant role for agriculture; relatively small manufacturing sector; basic financial market.
- Steady-state ratios of private consumption, investment, and government expenditures to GDP match Myanmar data.
- Labor force composition by occupation and sector matched.
- Consumption composition by product matched.
- Calibration reproduces Gini coefficients of consumption and poverty rates observed in Myanmar (most recent information: Gini index is relatively low (0.29) and about 38 percent of the population lives in poverty).
- Households face income shocks calibrated to reproduce observed distributional statistics.

### Economic structure and agents
- Four occupations: 
  - a. Agricultural workers (rural)
  - b. Entrepreneurs (urban)
  - c. Public sector workers (urban)
  - d. Private sector workers (urban)
- Households are largely confined to their sectors; fixed migration costs reproduce rural-urban income gaps.
- Production:
  - Agricultural workers use labor and intermediates to produce a domestically produced agricultural product (for consumption or for use in agricultural exports).
  - Entrepreneurs produce a nonfood item using capital and labor; nonfood can be consumed or converted into capital.
  - Agricultural exports (e.g., beans and pulses) are produced by entrepreneurs using domestic agricultural product and labor.
  - Public sector workers do not produce marketable goods.
  - Informal production: private/public sector workers can produce nonfood informally to avoid taxes.
- Preferences and household decisions:
  - Households live forever, are forward looking, decide consumption, savings, and money holdings.
  - Households are risk averse and use financial intermediaries for insurance and to smooth consumption.
  - Households allocate consumption across two food items (domestic and imported) and nonfood.
- Financial intermediaries finance entrepreneur investment and agricultural intermediates, and allow saving and borrowing.
- Fiscal policy parameters include:
  - Tax on entrepreneurs’ capital income
  - Tax on private and public sector workers’ wage earnings
  - Sector specific and means-tested transfers
- Idiosyncratic shocks: no aggregate uncertainty; law of large numbers implies a constant distribution of household shocks across sectors.
- Equilibrium: markets for three domestically produced goods, credit, and labor clear; prices of imported food and agricultural exports are exogenous; nominal savings interest rate is set by government regulation and monetary policy; real rates vary with inflation.
- The economy is analyzed in steady state (aggregate variables and prices constant over time; individual households experience time-varying idiosyncratic shocks).

### Reform scenarios considered
- Four policy experiments:
  - Financial liberalization:
    - Gradual liberalization of interest rates by allowing the deposit rate to rise by 1 percentage point and reducing the growth of money supply sufficiently to lower inflation by 2 percentage points.
    - Results in an increase in the real deposit rate and makes more financial resources available to the private sector.
    - Measures to reduce the share of loanable funds channeled to the public sector shift supply of financial resources.
  - Financial inclusion:
    - Includes financial liberalization measures plus easier access to private credit for a larger fraction of the agricultural sector.
    - Achieved via exogenous reduction in impediments to credit for farmers (accepting wider collateral, relaxing restrictions on banking hours, establishing a credit bureau).
    - Grants access to credit for previously excluded rural households (demand for loanable funds shifts).
  - Higher infrastructure investment (all sectors):
    - Financial inclusion scenario plus channeling higher tax revenues generated by higher growth toward infrastructure investment that improves productivity across all sectors.
  - Higher infrastructure investment in agriculture:
    - Financial inclusion scenario plus channeling higher tax revenues toward infrastructure investment that benefits the agricultural sector specifically.

### Illustrative results from reform scenarios — key quantitative outcomes
- Financial liberalization:
  - Industrial sector share of GDP increases by 5.6 percentage points.
  - Total private credit to GDP ratio increases by 2.25 percentage points.
  - GDP growth rate is nearly 2 percentage points above trend.
  - Private investment grows by 5.0  percentage points above trend.
  - Distributional effects:
    - Gini coefficient falls by 1.6 points.
    - Poverty rate falls by 5 percentage points.
    - Urban inequality increases slightly while rural inequality falls; poverty falls in both rural and urban areas (more pronounced decline in urban areas due to industrial concentration).
- Financial inclusion (credit expansion to rural sector):
  - Total private credit to GDP ratio and GDP growth rate are slightly lower than under financial liberalization (agriculture on average has lower productivity).
  - Rural agricultural output and farm income increase.
  - Rural inequality may increase (benefits accrue more to higher-productivity, larger land-holding households); national Gini decreases by 1.2 points.
  - Poverty falls by 4.4 percentage points nationwide.
- Infrastructure investment financed by reform-generated revenue:
  - Investing in infrastructure directed to all sectors:
    - Annual GDP growth rate 3.1 percentage points above trend.
    - Annual investment growth 7.4 percentage points above trend.
    - Industrial sector share of GDP 1.6 percentage points larger than in baseline.
    - Reduces Gini coefficient by 1.8 points (compared with baseline).
    - Poverty rate falls by 6.5 percentage points.
  - Investing in infrastructure focused on agriculture:
    - Annual GDP growth rate 2.3 percentage points above trend.
    - Annual investment growth 5.4 percentage points above trend.
    - Industrial sector share of GDP 11.0 percentage points smaller than in baseline.
    - Reduces Gini coefficient by 2.6 points.
    - Poverty rate falls by 6.4 percentage points.
- Comparative insights:
  - Infrastructure benefiting all sectors yields larger growth and investment gains.
  - Infrastructure targeted to agriculture yields better distributional outcomes for the country as a whole (greater reduction in Gini).

### Policy implications (from model results)
- Financial liberalization (with supportive macro conditions) can:
  - Significantly boost economic growth, reduce poverty, and improve nationwide income distribution.
  - Allowing increases in interest rates and phasing out CBM financing of fiscal deficits would lead to positive real interest rates, encourage household savings, increase credit supply, raise private investment, and foster growth.
  - The poor benefit from higher growth with reduced poverty, though proportionally less than the better-off (especially in urban areas with large informal sectors).
- Financial inclusion policies (increasing credit access for agriculture and SMEs):
  - Can further reduce poverty but may benefit the poor less unless policies target disadvantaged groups.
  - Targeted measures (e.g., well-targeted micro-finance schemes) are important to improve distributional outcomes.
- Infrastructure investment:
  - Amplifies the positive impact on growth and poverty of financial reforms.
  - Critical infrastructure (electricity, transport, telecom) improves financial access for the poor.
  - Trade-offs in sectoral priorities: rural infrastructure may deliver less aggregate growth than urban-directed investment but reduces rural-urban disparity.
  - Addressing intra-rural and intra-urban inequality requires policies targeting the poorest groups who may not fully benefit from improved infrastructure.
- Trade-offs and sequencing:
  - Achieving inclusive growth during financial sector reform will likely require trade-offs between growth, poverty, and distribution objectives.
  - Bringing down inflation by phasing out central bank financing of fiscal deficits helps protect the income of the poor.
  - As financial reform deepens (including interest rate liberalization), authorities need to assess trade-offs and design policies to achieve outcomes consistent with long-term inclusive development goals.

### Appendix — Model details (structural specifics)
- Model type: dynamic stochastic general equilibrium of a small open economy with multiple sectors and heterogeneous households.
- Household decisions: consumption, interest-bearing asset savings, money holdings; access to financial intermediaries provides insurance and borrowing capacity.
- Production specifics:
  - Entrepreneurs’ nonfood production uses capital and labor; capital cannot be converted back into nonfood consumption good; capital depreciates.
  - Agricultural exports produced by entrepreneurs using domestic agricultural product and private sector labor.
- Financial intermediation: intermediaries finance entrepreneurial investment and agricultural intermediates and provide saving/borrowing services to workers.
- Fiscal instruments: taxes on entrepreneurs’ capital income and on wage earnings; sector-specific and means-tested transfers.
- Shocks: idiosyncratic household productivity shocks; no aggregate uncertainty.
- Market clearing: prices, wages, and borrowing interest rates adjust to clear markets for domestically produced goods, credit, and labor.
- Nominal savings interest rate set by government; real interest rates vary with inflation; part of private savings finances government/SOE operations, remainder funds private credit.
- Steady state: aggregate variables and prices constant; distributions of wealth, income, and consumption constant; individual household variables evolve with idiosyncratic shocks.

*IMF staff estimates, model and results as presented in the chapter.*

### References

### References

### A. Myanmar’s Disaster Risk: Proneness and Vulnerability

- Myanmar is exposed to a considerable disaster risk due to the interaction of proneness to physical hazards and vulnerability of exposed material and human elements.
- Global and regional rankings cited:
  - "most-at-risk country in Asia and the Pacific according to the UN Risk Model (OCHA, 2012)"
  - "second-most affected country worldwide according to the Climate Risk Index (2016)"
- Disaster proneness (1970–2015; climate-related hazards predominate):
  - For DAS (including Myanmar), EM-DAT reports more than 3,200 events, causing US$590 billion in material damages, affecting 6 billion people and killing more than 1 million.
  - Climate-related disasters occurred 9 times more often, caused 12 times more material damages, affected 380 and killed 750 times as many people (climate-related versus geophysical disasters, DAS context).
- Table 1. Average Climate-Related Disaster Losses (1970–2015; annual occurrence per thousand square kilometers, material damages in percent of GDP, human damages in percent of population, conditional on an event):
  - Occurrences:
    - Myanmar: 0.0022
    - DAS: 0.0167
    - RoDW (w/o Myanmar): 0.0165
  - Material damage (percent of GDP):
    - Myanmar: 0.5659
    - DAS: 1.2919
    - RoDW (w/o Myanmar): 0.4481
  - People affected (percent of population):
    - Myanmar: 1.0508
    - DAS: 4.2132
    - RoDW (w/o Myanmar): 2.6235
  - People dead (percent of population):
    - Myanmar: 0.0091
    - DAS: 0.0020
    - RoDW (w/o Myanmar): 0.0032
- Patterns and notable events:
  - Myanmar tends to suffer from exceptionally severe rather than frequent small disasters.
  - Cyclone Nargis (May 2008): killed some 0.3 percent of population, caused around 12 percent of GDP in material damage, affected 5 percent of population.
  - 2015 floods: killed some 0.0003 percent of population, caused around 2.5 percent of GDP in material damage, affected 17 percent of population.
  - Casualties have declined since cyclone Nargis, partly due to advances in early warning and disaster preparedness.

- Disaster vulnerability:
  - Myanmar’s susceptibility falls into the second highest quintile (World Risk Index, 2015).
  - Coping capacity and absorptive capacity both fall into the weakest quintile.
  - Myanmar ranks 11 out of 191 in the Index of Risk Management (INFORM).

### B. Risk Outlook: Climate Change Exacerbation

- DAS countries likely to be among the hardest hit by climate change (IPCC, 2014a; GFDRR, 2015).
- Projections suggest temperature increases in DAS may be larger than the global land average (IPCC, 2014b).
- Consequences for Myanmar:
  - Increased frequency and severity of heat stress, extreme precipitation, inland and coastal flooding, drought and water scarcity, insect infestation and diseases.
  - Pressures on agriculture (crops, livestock, forestry, fisheries), water access, food and energy security, and health.
  - Risk of new poverty traps, population displacements, and conflicts, undermining economic, social, and political stability.
  - Potential for growth to suffer and fiscal pressures to mount to meet demands for public infrastructure and social services.

### C. Disaster Impact: Macroeconomic and Fiscal Effects

- Definition of a "severe" climate-related disaster in the analysis:
  - Events in the 90th percentile of annualized and scaled climate-related material damages across DAS.
  - Threshold of material damages: 1.12 percent of GDP.
  - 87 such cases identified (four occurred in Myanmar in 1991, 1992, 2008, and 2015).

- Short-term macro-fiscal mechanisms following severe disasters:
  - Immediate costs: loss of lives, damage to physical assets, immediate output contraction.
  - Fiscal strains: lower revenues (due to lower economic activity and disrupted tax collection) and higher expenditure needs (emergency relief and reconstruction).
  - External position: lower exports and higher imports (food and reconstruction materials).
  - Over time, macro-fiscal effects depend on:
    - Effectiveness of demand smoothing mechanisms (counter-cyclical fiscal policies, external assistance, remittances, insurance payouts).
    - Institutional quality (speed and usefulness of response measures).
    - Degree of crowding-out of productive capital expenditures by reconstruction.
    - Potential Schumpeterian creative destruction effects (investment in upgraded capital and new technologies).

### D. Cross-Country Evidence for DAS

- Panel-VARX results (17 DAS countries; severe disasters = top 10 percentile of material losses; 300 bootstraps):
  - Immediate and significant decline of mean growth of 1.2 percentage points in year t0.
  - Permanent growth loss of 2.2 percentage points over the medium term.
  - Limited dynamic fiscal response: mean reactions of government primary balance and expenditure-to-GDP ratio are small and statistically insignificant.
  - Large heterogeneity across countries (wide 10 percent confidence intervals), reflecting differences in absorptive capacity and policy response.

### E. Event Study Findings: Fiscal Responses and Dynamics

- Event study of DAS episodes where t0 is a year in the top 10 percentile of costliest climate-related disasters finds:
  - Growth decline corroborated.
  - Fiscal aggregates mask a range of policy responses:
    - Spending restraint in line with available resources: primary balance only mildly deteriorates; total spending slightly expands in the severe disaster year with higher total revenues (driven by non-tax revenues), then contracts thereafter.
    - Expenditure reallocation: lower capital expenditure to make room for current emergency relief, reversing in the second year for reconstruction; anecdotal evidence of reprioritization of capital expenditure and rationalization of current expenditure.
    - Revenue and external official support mobilization: pickup in average grants in the second year after the disaster; donors respond through project grants in reconstruction and immediate debt relief rather than immediate budget grants.
    - Public debt dynamics: initial slight improvement reflecting debt relief, then accelerated worsening due to lower growth and slightly higher overall deficits; stock-flow adjustments occur immediately after events (exchange rate depreciation, realization of contingent liabilities).
    - Concessional borrowing resumes slowly during reconstruction with little immediate effect on debt dynamics due to long grace periods.
- Specific event-study observations (mean paths, t-2 to t+2):
  - Real GDP per capita growth shows decline around t0.
  - Primary and overall fiscal balances show limited deterioration.
  - Total revenue: first differences show movements in total revenue, tax revenue, and grants.
  - Total expenditure: first differences highlight shifts in current expenditure and capital expenditure.
  - Public debt: first differences indicate swings including concessional debt and defaults.
  - External support: first differences track remittances, debt relief, and NODA.

*Source: IMF staff, "MACRO-FISCAL RISKS: THE CHALLENGE OF CLIMATE RELATED DISASTERS" (excerpt from cr1731 - References).*

### 12.      Meanwhile, the private sector’s disaster response partially substitutes for a public

### cr1731 - 12.      Meanwhile, the private sector’s disaster response partially substitutes for a public

### Private sector role in disaster response
- Comparing the evolution of the government’s capital expenditure (Figure 6.d) to that of the gross capital formation of the combined public and private sector (Figure 7) suggests that the private sector plays an important role in the disaster response.
- The private sector response even precedes the public response.
- The private sector response is facilitated by the availability of fast and fresh financing.
- While financial and insurance markets are still in a development stage in DAS, remittances are a more important source (Figure 6.f).
  - Remittances increase immediately after the disaster and continue to grow, first financing emergency relief and then reconstruction.

### The 2015 Floods in Myanmar — event description and impacts
- Event timing: July through September 2015 (cyclone Komen after making landfall in Bangladesh).
- Geographic scope: severe, widespread flooding and landslides across 12 of the country’s 14 states and regions.
- Human impact (according to EM-DAT and OCHA (2016a)):
  - Killed 171 people.
  - Affected more than 9 million people.
  - Temporarily displaced 1.7 million people (or 17 percent and 3 percent of the population, respectively).
- Economic impact (Myanmar PDNA (2016)):
  - Total economic impact of US$1.51 billion (or 2.4 percent of GDP).
- Relative severity: This event is in the top 10 percentile of all climate-related disasters in DAS countries over the past four and a half decades along two loss dimensions: material damages and people affected.

### Macroeconomic and fiscal aftermath
- Growth impact:
  - Relative to the pre-disaster year, growth turned out lower by 0.7 percentage points in FY 2015/16.
  - Authorities revised downwards the growth outlook for the near-term.
- Fiscal reaction:
  - A revised budget in late 2015 and the preliminary FY 2015/16 outcome did not show any substantial disaster response—neither in revenues, nor expenditures.
  - Authorities responded swiftly within their means, enabled by institutional and regulatory improvements after cyclone Nargis in 2008 (e.g., establishment of the Ministry of Social Welfare, Relief and Resettlement (SWRR), Disaster Management Law in August 2013, National Disaster Management Committee (NDMC), and Disaster Management Rules finalized in April 2015).
- Characteristics of the fiscal response (fell short of DAS peers’):
  - Adherence to the overarching objective of preserving the fiscal stance.
    - Although debt levels provided some fiscal buffer for counter-cyclical policy, the government opted for not expanding spending, citing a lack of external budget support and a philosophy of “living within your means.”
    - The authorities made a call for assistance to the international community, but external budget support remained absent—reflecting largely pre-election sensitivities of donors and the governments’ inexperience in dealing with donors.
  - Predominant reliance on the Reserve Fund—an annually earmarked budgetary provision for natural disaster and emergency projects.
    - The Reserve Fund was sizably topped-up since FY 2012/13 to K100 billion (from previously K100 million), but the fund was used up very quickly, only covering less than 1 percent of the total estimated damage.
  - Minor reliance on the National Natural Disaster Management Fund (NNDMF)—an off-budget fund created in 2013 (with an annual budget allocation of K20 billion) for immediate relief measures and monitoring of natural disaster risk mitigation projects at the supra-ministerial level.
    - It granted the Ministry of Social Welfare an additional K3 billion for emergency spending.
  - Some reprioritization within spending categories, reflecting severe budget rigidities.
    - Current financial rules and regulations (enacted in 1986) only allow for re-appropriations within the same budget line, i.e., line ministry (even project) and sub-federal bodies (i.e., state and regional governments).
    - The authorities did not request approval from cabinet and parliament to implement more substantial re-appropriations.
    - They used existing budget flexibility to respond to the most immediate spending pressures and submitted revised spending plans for the upcoming budget cycle.
- Note: Since the floods hit mainly rural areas, tax collection was not very much affected.

### Policy implications: importance of ex-ante resilience and ex-post policy response
- Overall need:
  - Myanmar needs to address weaknesses in ex-ante resilience and ex-post adaptive capacity.
  - While natural disasters cannot be prevented and their impact is unpredictable, Myanmar can reduce its macroeconomic vulnerability by addressing remaining weaknesses in fiscal policy, institution and capacity.
- Cross-country best practices and Myanmar’s experience suggest the following actions:

- Improve fiscal risk management and public financing assistance:
  - Incorporate disaster risks in fiscal management.
    - Explicitly identify and adequately integrate climate-related natural disaster risks into the medium-term fiscal framework and debt sustainability analysis.
    - This will help determine how much to spend on mitigating impact and how much to self-insure by creating an adequate fiscal buffer within the budget.
    - Unused funds should contribute to bolstering a notional fiscal buffer (i.e. generating public savings in quiet times for use in disaster times).
    - International best practices mandate reserving some 1 percent to 3 percent of spending to fiscal risks as such.
  - Clarify the role of the National Natural Disaster Management Fund (NNDMF), especially as to its mandate, governance structure, budget linkages, and relations with donors for disaster response and mitigation measures.

- Regularize budget process flexibility:
  - Integrate fiscal rules and the Disaster Management Law to ensure adequate flexibility to respond in a timely and effective way to a natural disaster.
  - This could include an escape clause for:
    - (i) determining the extent of a fiscal response in line with a severity classification;
    - (ii) redeploying expenditures across budget chapters; and
    - (iii) a streamlined process for preparing and passing a revised budget.

- Generate fiscal space to finance climate change mitigation and disaster response programs:
  - Enhance domestic revenue mobilization and tap into newly available international support to secure more resources for the integration of adaption to and mitigation of climate change in development planning in the context of the formulation of the country’s Sustainable Development Goals (SDGs).
    - A number of measures can help address macroeconomic vulnerability, including improving social safety nets, facilitating access to finance and insurance, and promoting disaster-resilient infrastructure (especially of physical transport and energy generation, public health capacity, risk-informed spatial planning, building standards, and payment systems).
  - Overhaul energy subsidies and taxation.
    - The current global environment of low fossil fuel prices and the Paris Agreement in 2016 provide an opportune moment to gradually eliminate poorly targeted energy subsidies, adjust artificially low electricity prices, and introduce carbon taxation.
    - The redistributive implications of such measures would require flanking measures, such as the introduction of well targeted subsidies for the most vulnerable.
    - At this juncture, the objective of carbon taxation would be rather to help guide a cleaner, more sustainable economic development than to raise revenues.
      - Myanmar’s share of 2012 global greenhouse emissions was 0.99 percent, but mainly on account of ongoing deforestation than old and dirty industries (Admiraal and others, 2015).

- Strengthen government effectiveness and institutional capacity:
  - Improve coordination and communication (not only within the public sector, but also with civil society, donors, and multilateral organizations), planning, information aggregation and management, policy design and implementation.
  - Strengthened government effectiveness also spills over to private sector disaster response.

*International Monetary Fund — content unit cr1731, excerpt on private sector substitution and Myanmar 2015 floods.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1731.pdf_