20 be, the broadening of the credit base may have been instrumental in improving employment prospects and income distribution.

Did financial reform, by reducing the degree of dispersion in the cost of credit, contribute to greater neutrality in the incentive structure of the economy? An in-depth analysis of this question is not possible, given the nature of the data base. There are no time-series data on lending rates or cost of credit on a sectoral basis. The only available data are those relating to the lowest and the highest lending rates of commercial banks and DFIs (Table 18). These data show that disparities in borrowing Lates increased substantially (or else, the credit allocation in the economy became less efficient) after 1977. But it could also be that interest rate deregulation made it easier for less desirable borrowers to get institutional credit.

The lower rate for commercial bank lending, as well **as** all rates of **the** DEF and NDB, were usually those applicable to loans to sectors accorded priority under the "directed" credit policy. Given an annual inflation rate of 5 to 12 percent during this period, these rates implied a negative real cost of capital to preferred borrowers. By contrast, the upper (market-determined) rates remained highly positive. The structure of lending rates therefore introduced credit market distortions and ran counter to the primary objective of trade liberalization--realizing gains from better allocation of resou:ces.

A major explanation for the wide gap between lending at favored or nonfavored rates seems to lie in the nature of the banking system itself. ihe opening of the banking system to foreign competition had only a marginal impact on the dominance of the two state-owned banks, in terms of both volume of transactions and extent of lending activities (Tables 1 and 2). The "old" foreign banks and the locally-owned private banks showed little interest in extending their operations beyond their traditional domain of trade financing, while the "new" foreign banks, were not eager to do business with purely domestic clients. The provision of long and medium-term finance ffr industry and agriculture continued to be the role of the state-owned banks. Given the compartmentalized nature of lending, there was little competition in loan rates. Added to this, the state-owned banks continued to be under pressure to set lending priorities and interest lending rates with the government's policy priorities. Since these banks were also expected to be profit-making institutions, relatively low (and at times negative) interest rates for priority clients usually implied excessively high rates for on non-priority borrowers.

Administered prioritv lending was based on the premise that "high" market-determined rates might deter long-term investment in the tradable sector and thus jeopardize the sustainabilitv of trade liberalization.<sup>2 0</sup> In lLactice, however. apart from introducing a significant element of distortion into the economv. this guided credit policy achieved little. By 1983. Lefinanced credit accounted for less than 5 percent of the total domn-stic loans ()f tommercial banks. and ab')ut two-thirds of this lending . This has been a recirrent theme in the annual financial-sector review in the Review i'f the Econona of the Central Bank.