Banks groan under liquidity stress
Tuesday, 24 May 2011
Abu Zawad
The problem facing our policymakers as we head into inflationary pressure along with the responsibility of growth of the economy is surprisingly simple, yet very unpalatable. The private commercial banks (PCBs) are facing a tough time to mobilise deposits for maintaining their liquidity under double pressure in line with the statutory requirements and the existing credit deposit ratio (CDR). This is for the central bank as it continues pursuing the dual objectives of maintaining price stability and supporting faster economic growth and poverty reduction. For sure, mass expectations of higher inflation have proven to be a self-fulfilling prophecy in the past via aggressive wage bargaining and firms' greater confidence in their pricing power. But timely and pre-emptive interest rate rises by the central bank to have proven to be powerful in containing those expectations. So, gauging that balance of risks right now has rarely been more critical to money managers. Post-recession recovery warrants the presence of inflation as a desired strategic option. But Bangladesh Bank does not allow a little increasing inflation as prevailing now for understandable political reason or other. The problem is, once inflation has spread to other sectors there is no alternative to monetary tightening. Unfortunately, monetary policy acts with a long and indeterminate lag. Along with some monetary tightening, the government needs also to act on fiscal discipline and removing artificial barriers to efficient prices, such as higher than warranted import duties etc. In recent months, the exporters have been suffering from the bankers' unusual reluctance to provide necessary funds as advance against the export bills. The exporter, who banks with a first-generation private sector bank, said that almost every exporter had become used to receive such advance funds for meeting the diverse costs of operating businesses. The severe liquidity crisis is a much-talked-about issue now, with at least half a dozen private sector banks running short of money. The president of the Bangladesh Garment Manufacturers and Exporters Association said that the unavailability of timely funds is hampering their business seriously. The refusal of the bankers to provide funds in advance and the sharp increase in the rates of interest has now become major hindrances to the export business. One chief executive of a private sector bank admitted that the tight liquidity situation had made many banks unable to satisfy their clients in the export business. The situation has been very bad in many banks in the past few months, especially, after the stock market debacle in mid-December of 2010. Furthermore, the banks are in difficulty in meeting their obligations for settlement of letters of credit (LCs) in keeping with their earlier commitments due to a heavy pressure on their currently available fund. Before such apocalyptic fear takes hold, we should make a reality check on what we have now. Before the present inflationary pinch is felt, the features of the economy were: slower domestic activity, particularly in the first half of FY'10, larger current account surplus due to slower imports and buoyant remittance inflows, excess liquidity in the banking system, due to slower private sector credit demand and also reflecting the sharp increase in net foreign assets (NFA) of the banking system. Excess liquidity in the Banking System made the Interbank Market Dysfunctional. Interventions to mop up the excess liquidity had been delayed. There was real risk that much of the liquidity would spill into the stock market and real estate and encourage financial institutions to engage in other speculative off balance-sheet activities. Such developments might potentially create other major problems for the economy and for the viability of those institutions down the line. Earlier, with the availability of higher liquidity surplus as mentioned above, some banks tried to deploy their fund as much as possible to reap the desired profits as the Bangladesh Bank did not enforce seriously the credit deposit ratio. Moreover, the banks had made their credit planning considering the existing CRR and CDR. It means the banks' credit planning was made in acceptance with the assumption that the Bangladesh Bank would continue pursuing the existing monetary policy to support the sound macroeconomic management. We observe that after the recent deep recession, the western economy has just started experiencing the price-hike of the essential commodities extending its impact on our import-based economy. This requires our banking system to deploy more funds to import the same quantity of goods. With jobs becoming redundant, numbers travelling not up to expectation and severe cost-cutting, the reported slowdown in remittance growth figures was not unexpected. Furthermore, higher import price coupled with less inflow of foreign remittance due to ongoing middle-east unrest created tremendous pressure on availability of foreign currency to meet the import payments. Under such a situation, the central Bank took the decision to raise the CRR and CDR ratio to achieve the objectives of contractionary monetary policy. Some particular western countries have intentionally turned their export basket costlier than before by way of new harmonised tax, hiked transportation fare and new added costs for essential commodities. Thus, the prices of essential commodities like food items, cotton, other industrial raw-materials etc have increased as a result of which banks cannot maintain the existing credit deposit ratio. If sufficient essential goods cannot be imported as banks now become unable to finance the import trade due to contractionary policy originating from tight CRR and CDR ratio, the resultant figure would be price soaring or igniting inflationary elements in the economy again. Moreover, in such a situation while the central Bank is pursuing a contractionary monetary policy, the government has raised the energy price (gas) which creates the further pressure on inflation. Allowing various economic factors that ignite inflation along with contractionary monetary policy would not only accelerate the inflation, but also hinder the growth phenomena of the economy. The instruments available at the disposal of the central bank, namely variations in cash reservestatutory liquidity requirements and operations in treasury bonds, cannot exert significant influence on the target variable, namely, money supply. Moreover, in the import-dependent economy like Bangladesh, domestic prices are largely determined by international prices. Hence, monetary policy is bound to be ineffective in containing inflation. The situation now prevailing in the economy suggests that measures under CRR and CDR to get a grip on inflation might not put a dent, but in turn create imminent threats which may have impact on lending and growth if not carefully addressed. However, the central bank's aggressive 50 bps hike and the likelihood of continuation of this may hamper manufacturing growth by raising the cost of borrowing funds and slowing robust domestic demand. If manufacturing growth drops to about 6.0 per cent this fiscal year, GDP expansion may come down by about 0.4 percentage points. Focusing only on aggressive monetary tightening at a time when growth indicators are already faltering could choke growth with only a limited effect on taming inflation. Therefore, we may have one option that the central bank can do is to delay the enforcement of CRR and CDR by another six months, so that the banks may take breath to restore the situation with the result in certainty. Thus, the crucial phase that Bangladesh economy is going through warrants steady steering to balance between inflation and economic growth for the sake of badly felt unemployment, poverty reduction, availability of goods to ensure price stability etc. The writer is of the Centre for Research and Development
The problem facing our policymakers as we head into inflationary pressure along with the responsibility of growth of the economy is surprisingly simple, yet very unpalatable. The private commercial banks (PCBs) are facing a tough time to mobilise deposits for maintaining their liquidity under double pressure in line with the statutory requirements and the existing credit deposit ratio (CDR). This is for the central bank as it continues pursuing the dual objectives of maintaining price stability and supporting faster economic growth and poverty reduction. For sure, mass expectations of higher inflation have proven to be a self-fulfilling prophecy in the past via aggressive wage bargaining and firms' greater confidence in their pricing power. But timely and pre-emptive interest rate rises by the central bank to have proven to be powerful in containing those expectations. So, gauging that balance of risks right now has rarely been more critical to money managers. Post-recession recovery warrants the presence of inflation as a desired strategic option. But Bangladesh Bank does not allow a little increasing inflation as prevailing now for understandable political reason or other. The problem is, once inflation has spread to other sectors there is no alternative to monetary tightening. Unfortunately, monetary policy acts with a long and indeterminate lag. Along with some monetary tightening, the government needs also to act on fiscal discipline and removing artificial barriers to efficient prices, such as higher than warranted import duties etc. In recent months, the exporters have been suffering from the bankers' unusual reluctance to provide necessary funds as advance against the export bills. The exporter, who banks with a first-generation private sector bank, said that almost every exporter had become used to receive such advance funds for meeting the diverse costs of operating businesses. The severe liquidity crisis is a much-talked-about issue now, with at least half a dozen private sector banks running short of money. The president of the Bangladesh Garment Manufacturers and Exporters Association said that the unavailability of timely funds is hampering their business seriously. The refusal of the bankers to provide funds in advance and the sharp increase in the rates of interest has now become major hindrances to the export business. One chief executive of a private sector bank admitted that the tight liquidity situation had made many banks unable to satisfy their clients in the export business. The situation has been very bad in many banks in the past few months, especially, after the stock market debacle in mid-December of 2010. Furthermore, the banks are in difficulty in meeting their obligations for settlement of letters of credit (LCs) in keeping with their earlier commitments due to a heavy pressure on their currently available fund. Before such apocalyptic fear takes hold, we should make a reality check on what we have now. Before the present inflationary pinch is felt, the features of the economy were: slower domestic activity, particularly in the first half of FY'10, larger current account surplus due to slower imports and buoyant remittance inflows, excess liquidity in the banking system, due to slower private sector credit demand and also reflecting the sharp increase in net foreign assets (NFA) of the banking system. Excess liquidity in the Banking System made the Interbank Market Dysfunctional. Interventions to mop up the excess liquidity had been delayed. There was real risk that much of the liquidity would spill into the stock market and real estate and encourage financial institutions to engage in other speculative off balance-sheet activities. Such developments might potentially create other major problems for the economy and for the viability of those institutions down the line. Earlier, with the availability of higher liquidity surplus as mentioned above, some banks tried to deploy their fund as much as possible to reap the desired profits as the Bangladesh Bank did not enforce seriously the credit deposit ratio. Moreover, the banks had made their credit planning considering the existing CRR and CDR. It means the banks' credit planning was made in acceptance with the assumption that the Bangladesh Bank would continue pursuing the existing monetary policy to support the sound macroeconomic management. We observe that after the recent deep recession, the western economy has just started experiencing the price-hike of the essential commodities extending its impact on our import-based economy. This requires our banking system to deploy more funds to import the same quantity of goods. With jobs becoming redundant, numbers travelling not up to expectation and severe cost-cutting, the reported slowdown in remittance growth figures was not unexpected. Furthermore, higher import price coupled with less inflow of foreign remittance due to ongoing middle-east unrest created tremendous pressure on availability of foreign currency to meet the import payments. Under such a situation, the central Bank took the decision to raise the CRR and CDR ratio to achieve the objectives of contractionary monetary policy. Some particular western countries have intentionally turned their export basket costlier than before by way of new harmonised tax, hiked transportation fare and new added costs for essential commodities. Thus, the prices of essential commodities like food items, cotton, other industrial raw-materials etc have increased as a result of which banks cannot maintain the existing credit deposit ratio. If sufficient essential goods cannot be imported as banks now become unable to finance the import trade due to contractionary policy originating from tight CRR and CDR ratio, the resultant figure would be price soaring or igniting inflationary elements in the economy again. Moreover, in such a situation while the central Bank is pursuing a contractionary monetary policy, the government has raised the energy price (gas) which creates the further pressure on inflation. Allowing various economic factors that ignite inflation along with contractionary monetary policy would not only accelerate the inflation, but also hinder the growth phenomena of the economy. The instruments available at the disposal of the central bank, namely variations in cash reservestatutory liquidity requirements and operations in treasury bonds, cannot exert significant influence on the target variable, namely, money supply. Moreover, in the import-dependent economy like Bangladesh, domestic prices are largely determined by international prices. Hence, monetary policy is bound to be ineffective in containing inflation. The situation now prevailing in the economy suggests that measures under CRR and CDR to get a grip on inflation might not put a dent, but in turn create imminent threats which may have impact on lending and growth if not carefully addressed. However, the central bank's aggressive 50 bps hike and the likelihood of continuation of this may hamper manufacturing growth by raising the cost of borrowing funds and slowing robust domestic demand. If manufacturing growth drops to about 6.0 per cent this fiscal year, GDP expansion may come down by about 0.4 percentage points. Focusing only on aggressive monetary tightening at a time when growth indicators are already faltering could choke growth with only a limited effect on taming inflation. Therefore, we may have one option that the central bank can do is to delay the enforcement of CRR and CDR by another six months, so that the banks may take breath to restore the situation with the result in certainty. Thus, the crucial phase that Bangladesh economy is going through warrants steady steering to balance between inflation and economic growth for the sake of badly felt unemployment, poverty reduction, availability of goods to ensure price stability etc. The writer is of the Centre for Research and Development