One of the challenges faced by transitional and developing countries is to transform and improve, both structurally and behaviorally, their payment system in order to meet the needs of emerging market economies. Financial institutions and markets rely on the payment system to cost-effectively mobilize, allocate, and transform domestic and international savings flows into productive investments. The payment system also transfers value from households and enterprises when goods and services, produced by these investments, are consumed. The efficiency of both of these tasks is highly dependent on the existence of a convenient, cost-effective, and low risk means of delivering payment information and transferring value from one entity to another, point-to-point, i.e., a payment system. The three essential elements of a payment system are:

1. the initiation of instructions by a debtor to make a payment to a creditor (by check, bank or postal GIRO, debit or credit card, telephone call, or some other means);
2. the transfer of payment information (by post, courier, or electronic means) among banking institutions enabling the payor's institution to debit the payor's account and the payee's institution to credit the payee's account; and,
3. the settlement of the transfer of funds between banking institutions, usually through accounts held by banks at the central bank.

The purpose of this paper is to outline and discuss the major issues associated with transforming and improving payment systems in emerging market economies. A nation's payment system is intimately related to the development of money and capital markets and the implementation of monetary policy. In this sense, a payment system is somewhat analogous to an effective internal transportation system where the layout and connections between roads, highways, and other transportation modes in a country has a profound effect on the future pattern of trade and development in an economy. This is why a payment system project is regarded as a policy matter, not a simple technology issue.

Our goal is to provide a framework in which the basic elements important to transforming a payment system are explained (for the novice) and their interrelationships shown (for the informed reader). In this process, a number of questions are in effect posed and answered, such as:

• What are the main problems raised in transforming a payment system in formerly centrally-planned economies?
• How similar or different are payment systems in different market economies?
• What are the main risks in making large value, inter-enterprise payments and how can they be minimized?
• What are the specific steps taken when making a payment with different payment instruments and how can this process be improved?
• How have payment systems evolved in developed countries and what does this imply for emerging market economies?
• Why might electronic payments be favored over paper-based non-cash payments?
• What information is needed to properly plan for payment system improvements?

In what follows, the broad, major differences in payment systems between centrally-planned and market economies are first outlined and ways to improve the functioning of the payment system in transitional economies are noted. Although the example of payment systems in centrally-planned economies is used to contrast this difference, the problems identified are applicable to developing countries as well. Second, to gain a deeper understanding of some of the more complex payment system issues faced by transitional economies (as well as developing countries), a detailed model of the payment cycle is presented. With such a model, choices among alternative access, communication, and security arrangements become clearer and it is easier to see where and how different payment instruments fit into the national payment cycle. Third, the needs of an evolving and market-driven payment system are outlined. The importance of a country's legal and institutional structure is illustrated by contrasting the different evolutionary paths taken by the U.S. and European payment systems over time. The paper ends with a discussion of the many issues needing to be raised - from payment instrument design to cost recovery - to provide users with an effective payment system. Lastly, an Appendix provides a summary checklist of information needed to adequately plan for payment system change.