An investor needs money to invest, which may not always come from own funds, requiring the investor to resort to credit from different sources. Commercial banks by far are the main source of credit for investors. About 40 per cent of total private investment is financed by them. While the availability of credit from commercial banks has not been a serious constraint for Bangladeshi investors so far, the high interest rate has allegedly emerged as one of the main roadblocks to investment.
Here lies the importance of credit at an affordable interest rate. Several factors drive the interest rate high in Bangladesh. First, the high inflation, averaging at around 7.0/8.0 per cent in the recent years, obliges the commercials banks to pay an equally high interest rate on deposits to collect the loanable funds from savers. This high cost of mobilising deposits is eventually passed on to the borrowers in the form of high lending (interest) rate.
The problem of high interest rate on deposits is also intensified by the prevalence of bad financial tool/asset. With economic growth, the amount of surplus also grows, which needs to be captured by the mainstream financial sector, to be more precise by the banking sector in the context of a developing country like Bangladesh. So far, our banking sector failed to capture the surplus generated in the rural economy. By taking advantage of this, a number of informal and quasi-formal institutions have developed over time to capture these surpluses. The much-talked-about Destiny Group is just one of them. Numerous similar local organisations of different sizes are observed all over the country. They offer apparently lucrative financial asset to collect the surpluses, which stands as a hindrance to any potential decrease of interest rate on deposits.
There are also allegations that the new banks, which were approved very recently, offer 'irrationally' high interest rates to collect deposits forcing the other banks to do the same.
Second, while giving credit to an investor, a commercial bank has to add a margin with deposit interest rate to meet its administrative cost and ensure certain profit for the owner of the bank. Because of the administrative inefficiency of the bank, this margin seems to be high in Bangladesh compared to many other countries.
Third, another reason why interest rate is high in Bangladesh is the prevalence of 'bad loans'. Many loans are approved simply because of political influence, corruption, and nepotism. Many of such loans are not fully paid back causing financial loss to the banks. What the commercial banks do to recoup for this loss is charge high interest rate on other credits. The prevalence of bad loans not only results in high spread but also make it difficult for genuine investors to get credits. Thus the bad credits drive away the good credits.
These root causes of high interest rate in Bangladesh will require time to be resolved. Probably, accepting the fact that interest rate in Bangladesh would remain to be high in the foreseeable future, local investors are now encouraged to borrow from foreign sources where interest rates are apparently low. The most pertinent question in this context is to what extent foreign borrowing could be a substitute for domestic borrowing.
For any kind of domestic borrowing, interest is the only cost. If it is agreed upon in the contract instead of keeping it floating, the borrower is not subject to any other cost. The macroeconomic instability, volatile domestic as well as international money and capital market will not have any implication on the cost of borrowing, i.e., the interest expense. But for any kind of foreign currency-denominated borrowing, the borrower is exposed to two kinds of costs. One is the agreed interest, which, if agreed upon in the contract will remain fixed. The second is the foreign exchange cost. For example, if the foreign currency appreciates between the time of borrowing and repayment, the borrower has to effectively pay this appreciated amount in addition to the agreed interest to the lender.
Let us consider an example. In January 2009, the exchange rate of US dollar vis-à-vis Taka was about 68.90. Suppose, a private investor of Bangladesh borrowed 1.0 US dollar from an external source at an interest rate of, say 4.0 per cent per annum, in January 2009, which has to be repaid in January 2012. Keeping it simple, in January 2012, this investor has to repay 1.12 US dollar to the lender.
The exchange rate of US dollar vis-à-vis Taka in January 2012 was about 84.45 (source: Bangladesh Bank). Thus the value of his repayment in Bangladeshi taka is about 95, meaning that total cost of borrowing of 1.0 US dollar (which was equal to 68.90 Taka) from foreign source is about 26.1 taka, i.e., 12.62 per cent per year, not 4.0 per cent only.
Borrowing from foreign sources can still be cheaper compared to the borrowing from domestic source even after taking account of foreign exchange appreciation cost. Especially, the value of dollar against taka has been stable for quite some time. In this situation, high foreign exchange appreciation cost may not deem to be a concern. However, there is no guarantee that value of dollar against taka would remain the same when dollar-denominated foreign borrowing becomes payable. Any domestic shock or international shock transmitted in the domestic sector through trade channel may erode the current stability.
This is not to imply that borrowing from foreign sources by private investors should be avoided but to stress that actual cost of such borrowing may not be as low as it seems. Investors should remain fully aware of it to take preemptive measures whenever required.
In addition to this added cost, borrowing from foreign sources also involves a macroeconomic implication that the policymakers cannot ignore. Referring back to our earlier example again in which a private investor borrowed 1.0 us dollar from a foreign source in January 1, 2009 with a maturity period of three years, Bangladesh must have a 1.12 US dollar in January 01, 2012 ready to pay back to the foreign lender. Actual amount of dollar needed to pay back the foreign borrowings depend on the amount of total borrowing and the agreed rate of interest.
There have been many instances where a country struggled to manage the amount of dollar required to pay its total foreign borrowing. Such a situation depreciates local currency. The most recent example is India. Following the global economic and financial crisis of 2008, the country financed its investment and development activities through dollar-denominated short-term credits. By the last quarter of 2013, India became liable to repay about 172 billion US dollar of its short-term credit. At that time, the country had a reserve of foreign exchange of about 272 billion dollar. That is the amount of immediately payable debt of India accounted for about 64 per cent of its total foreign exchange reserve. As a result, the value of rupee against dollar declined significantly for some time putting a brake on the country's soaring economic growth.
If there are any lessons to be drawn from Indian experience they will include not to depend so much on short-term borrowing from foreign sources and remain vigilant so that total dollar-denominated payables, inclusive of both private and public foreign borrowings, does not become a concern for the country.
As a resource-scarce country, investment through borrowing from external sources can potentially provide an economic boost in Bangladesh. However, the investors need to be prudent in securing such borrowings and the policymakers need to remain vigilant so that the country’s total foreign borrowings do not become too much for it to shoulder.
Abul Basher, PhD is Researcher at Bangladesh Institute of Development Studies (BIDS), former economist, World Bank, and former faculty, Willamette University, USA. [email protected]
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