Difficulties in external borrowing

Bangladesh has been very slow and cautious in opening up of its capital account transactions including private sector borrowing in foreign currency from abroad. The foreign borrowing market in Bangladesh was highly controlled and virtually non-existent even a decade ago and access to foreign financing by the private sector was strictly controlled. Until 2008, the domestic private sector, barring some special cases/circumstances, were not allowed to borrow from foreign sources, even though foreign borrowings could be made at lower lending rates than those charged by the domestic banks and other financial institutions. Following an improvement in the foreign exchange reserve position of Bangladesh Bank, the government decided to liberalise such borrowing in the year 2008 primarily for the import of capital goods of new projects and modernisation of existing projects, and for sectors defined in the country's industrial policy.
The isolation of domestic financial sector from international capital market was a deliberate policy which, in part, was also dictated by the weakness of the country's balance of payments and inability of Bangladesh to access the international market in the absence of strengthened macroeconomic stability and a respectable country rating for foreign investors to assess country risk. The isolation of domestic financial market-particularly for borrowing from abroad by the domestic private sector-has contributed to high domestic interest rates, inefficient banking operations/management as reflected through high spread between deposit and lending rates and high levels of nonperforming loans, and also encouraged governments to continue with much higher inflation rates compared with Bangladesh's major trading partners.  Since banking sector is the most important component of Bangladesh's financial system, these inefficiencies and the consequent high interest rates contribute to higher cost of doing business in Bangladesh compared to most other countries.
This paper essentially puts forward the case for further integration of Bangladesh financial system with the international capital market. It argues that Bangladesh Bank and government's efforts to lowering of domestic interest rates and maintaining exchange rate stability have been frustrated in the past largely due to higher domestic inflation (compared to trading partners) and a lack of integration with the international capital market. The paper presents the evidence that recent modest liberalisation of private sector foreign currency-denominated borrowing and deceleration of inflation have contributed to lowering of domestic interest rate structures. While closer monitoring of the opening up process will be important in order to avoid situations like the East Asian Crisis with overexposure to international capital market and vulnerability to economic contagion, Bangladesh cannot allow itself to remain disconnected from the international capital market.   
CURRENT SITUATION: Bangladesh enjoys continued macroeconomic stability over a reasonably long time in terms of strong balance of payments, manageable public debt and good fiscal management. This stability notwithstanding, Bangladesh has high interest rates structure (both in nominal and real terms), much higher inflation rates compared to its trading partners, and very limited access to private foreign borrowing. These unfavourable developments tend to limit domestic investment and contribute to exchange rate instability in both real effective and nominal terms.

MACROECONOMIC STABILITY WITH HIGH REAL INTEREST RATES: Despite macroeconomic stability Bangladesh economy could not come out of the steady 6.0 per cent plus growth rate levels because of stagnation of domestic investment in the range of 24 per cent-26 per cent of GDP (gross domestic product) levels over more than one decade. In addition to a number of other factors such as infrastructure deficiency and lack of serviced land, higher lending rates charged by banks are often quoted as an important impediment against investment by the private sector. Until recently, the borrowing rates used to be 16 per cent-18 per cent in nominal terms.  Only recently the interest rate structure has started to come down to 12 per cent-14 per cent range due to increased competition from foreign currency borrowing, a deceleration of the domestic inflation rate, and slower domestic economic activity.
The spread between the lending and deposit rates however still remain high at 5.5 per cent-6 per cent range and somewhat widening in recent months, indicating inefficiencies in the banking system. Higher and growing burden of classified loans and the associated provisioning requirements have also contributed to this widening of the spread. Foreign commercial banks are taking advantage of this situation by charging even higher spread and making greater profits in the domestic market.  The recent decline in deposit rates have not been fully passed on to the borrowers in terms of lower lending rates, allowing banks to pass on their inherent inefficiencies to the depositors and borrowers, at least to a large extent.
The spread in Bangladesh banking system is certainly excessive. In most well-managed banking system, due to enhanced competition and better risk management of their loan portfolios, the spreads generally tend to be at or below 3.0 per cent.

MUCH HIGHER INFLATION RATES RELATIVE TO TRADING PARTNERS: Bangladesh has generally experienced higher inflation rates compared to its trading partners, which are mostly industrial and emerging economies. The 10-year (FY2004-FY2014) average inflation rate in Bangladesh was 7.9 per cent, while the corresponding average for the industrial economies was only 2.3 per cent.
Certainly the differential inflation rates cannot continue forever without a corresponding impact on the relative exchange rate. The Purchasing Power Parity (PPP) principle while not relevant or significant in the short-term, over the long term would certainly impact the levels of bilateral exchange rates.  The currency of the relatively high-inflation country would depreciate in nominal terms as happened in the case of Bangladesh steadily over the long term. In the event the nominal exchange rate is kept unchanged, the exporters would tend to lose export competitiveness with the appreciation of the domestic currency (high inflation country) in real effective terms.  
In recent months, with Bangladesh inflation remaining high, the relative stability of Bangladesh taka against the US dollar has simply contributed to a sharp appreciation of Bangladesh taka in real effective terms. The loss of export competitiveness is already significant and if the level of inflation in Bangladesh remains high in the coming months, the competitiveness of Bangladeshi exports in the world market will suffer.
RECENT LIBERALISATION IN FOREIGN BORROWING BY BANGLADESH BANK: Until 2008, the local businesses, barring some special cases, were not allowed to borrow from the foreign sources that offer loans at lower lending rates than those charged by the domestic banks and other financial institutions. After substantial improvement in the foreign exchange reserve position, the government decided to allow such borrowing in the year 2008 only for the import of capital goods of new projects and modernisation, and other sectors defined in the country's industrial policy. Due to a healthy reserve position, outside lenders and others started making available a considerable volume of funds to Bangladeshi entrepreneurs. In the past six years, Bangladesh Bank has allowed private firms to borrow $5.56 billion from foreign sources at lower interest rates of around 5.0 per cent-6.0 per cent. In its monetary policy   for July-December FY15, the central bank set the private sector borrowing ceiling at 16.5 per cent for the second half of the year, with 2.5 per cent coming from foreign borrowing. This is an explicit recognition that foreign currency-denominated borrowing will continue to play an important role in the sourcing of private sector credit.
A sectoral classification of the approved foreign loan portfolio for the private sector during 2009-14 shows that, the telecommunication/ISP sector accounted for 42.6 per cent of the total. The second and third highest approved loan amounts were granted for the power and RMG-related firms, which accounted for 18.6 per cent and 12.5 per cent of the cumulative approved loans for the period.  The highest recipient of foreign loans, the telecommunication/ISP sector, is exposed to relatively less risk since most of them are subsidiaries of large international parent telecom companies/congolomerates. In comparison, most of the power sector and RMG sector projects are owned domestically.
A study conducted by the Bangladesh Bank on foreign borrowing by the private sector indicates that while the amount of loans approved has increased significantly in the last five years, the amount of loan disbursed has in fact declined. The total loan approved for 2012 was $1.58 billion of which only $0.528 billion was disbursed. The amount disbursed in 2013 was $0.393 billion while total approved loan was $1.55 billion. The low disbursement rate of 35 per cent and 25.3 per cent for the two years is a cause for concern, as it indicates weakness on the part of the borrowers in terms of their ability to meet the financial standards set by international lenders in the context of granting such loans. Table 2 shows the net outstanding foreign currency-denominated loans was only $1.52 billion in 2012 and $1.74 billion in 2013.
A survey report of the Bangladesh Bank states that these loans were mostly used for importing foreign capital machineries, expansion of existing projects and establishing new ones.  The report also states that 'some of the external loans have been used to pay off more expensive local loans and one company used the loan to settle its L/C payment obligations (Deferred L/C). The survey pointed to three major potential/actual difficulties in external borrowing:
n Exchange rate fluctuations: Companies, which are not export-oriented, do not earn in foreign currency. Hence unfavourable exchange rate fluctuations lead to losses in local currency when servicing their foreign currency-denominated loans.
n Borrowing from off-shore banking units: One company, which borrowed from the off-shore banking unit of a local bank, faced significant losses as the bank was unable to continue foreign exchange financing and switched to higher cost local financing.
n Lengthy procedure of loan approval: The loan application and approval process takes considerable time, which acts as hindrance for some companies which require financing urgently.

Dr. Ahsan H. Mansur is Executive Director of the Policy Research  Institute of Bangladesh (PRI).
ahsanmansur @gmail.com