Liberalisation of access to foreign loans

The main reasons for the private sector to seek foreign loan is the interest rate differentials between foreign currency-denominated (international) borrowing and taka-denominated borrowing from domestic banks. Interest rates charged on foreign currency-denominated loans provided to the private sector are  generally set in the range LIBOR plus 3.0 per cent-4.5 per cent, the spread over LIBOR (at 3.0 per cent-4.5 per cent) being the combined mark-up charged by the facilitating domestic commercial banks and the counterpart foreign lenders. The domestic lending rates at present vary between [11 per cent-14 per cent] depending on the customer, which is still high and is acting as a deterrent for investment and private sector borrowing. In terms of foreign rates, there are two main contributing variables -- the level of LIBOR and the exchange rate between US dollar and Bangladesh taka.

Despite this enhanced stability of the exchange rate of Taka against the US dollar in recent years, the market and the borrowers however still continue to expect the annual exchange rate depreciation of about 3.0 per cent or more while making their decisions to go for dollar denominated loans. Therefore, considering the LIBOR to be 0.55 per cent, an intermediation mark-up of 4.5 per cent, and additionally accounting for the exchange rate risk factor of about 3.0 per cent, the cost of borrowing (in taka equivalent terms) from the foreign lenders would be about 8.0 per cent (Mark-up 4.5 per cent+Libor 0.55 per cent+Expectation with respect to exchange rate depreciation of 3.0 per cent= cost of borrowing 8.0 per cent). This rate is still significantly lower than the rates charged by the domestic banks to domestic prime borrowers.
The main reason behind the exchange rate fluctuations is usually the inflation rate differential between Bangladesh and its major trading partners. As we know it very well, domestic inflation rate in Bangladesh is much higher than the inflation rates of its trading partners. Additionally, if borrowers are concerned about the uncertainties associated with the exchange rate depreciation induced increase in cost of fund, they may hedge their risk in the forward foreign exchange market which would give them additional security.
Liberalisation of access to foreign loans will definitely create pressure on the local banks to reduce their lending rates in order to compete with foreign lenders. Since 2012, there has been a steady decline in private sector credit demand as private sector credit growth came down to a 13-year low of 11 per cent at the end of November 2013 and banks' loan-to-deposit ratio declined to around 71 per cent in December 2013. While this deceleration has been primarily caused by a slowdown in the economy and a lack of investor confidence due to the political instability in the country, the growing presence of foreign lenders has also been a factor. It is interesting to observe that domestic average lending rate charged to the private sector has seen a modest decline of 1.0 percentage point -- from 14.69 per cent in December 2012 to 13.68 per cent in June 2014. This coincides with the period during which borrowing from foreign lenders picked up significantly. While this decline in the domestic average lending rate is a positive sign, the interest rate differential vis-à-vis foreign currency borrowing is still too large to ignore and the domestic lending rates must come down further for the domestic currency lenders to be able to compete with foreign currency denominated lenders.

The slower growth in domestic private sector credit expansion, sluggish domestic private sector investment outlook and increased completion from foreign currency denominated lending, are likely to keep pressures on for further lowering of domestic lending rates. Faced with these intensifying pressures, domestic banks are also pushing down the interest rates on taka-denominated bank deposits. The average private commercial bank (PCB) deposit rate has already declined from a recent peak of 9.3 per cent in April 2013 to about 8.1 per cent at the end of June 2014.  This declining trend in both deposit and lending rates is likely to continue in the near term, in particular, if the inflationary pressures decelerate further in the coming months.

ARE LOWER INTERNATIONAL BORROWING RATES STIMULATING COMPETITION WITHIN THE BANKING SYSTEM? It is generally believed that despite the presence of a large number of banks operating in the domestic market, interest rates in Bangladesh (both deposit and lending) have always been considered (particularly the business community) to be much higher than what they should be. It is also observed that the spread between lending and deposit rates has always been much higher than many of Bangladesh's comparators and regional countries.
As mentioned above, the domestic lending rates are already on the decline due to the increased competition from foreign lenders. The deposit rate has also declined from 9.04 per cent to 8.13 per cent from June 2012 to June 2014, which indicates an increase in spread. The spread in Bangladesh is also relatively higher than other comparator countries like China, Malaysia and Thailand, shown in figure. In a well managed and relatively efficient banking system the level of spread could be as low as below 3.0 per cent, compared to 5 per cent or more for Bangladesh. The higher spread in Bangladesh is a manifestation of structural weaknesses or inefficiencies of the banking system as a whole. This increase in spread may be explained by the increase in loan loss provisions due to provisioning requirements associated with increased classified loans in the banking system. In particular, the recent series of loan scams and defaults have left many commercial banks, especially public sector ones, in a precarious position. The very high corporate tax rate applied on pre-tax profits of commercial banks (at 42.5 per cent) may also partly explain the greater spread in Bangladesh.

However, the weak credit demand and increased external borrowings by the private sector have led to the swelling of excess liquidity in the country's banking sector. Bankers said the local banking industry is now sitting idle on surplus liquidity - more than BDT 800 billion - because of non-utilisation of funds. The excess liquidity of the country's banks increased by BDT 240 billion or 40 per cent during January-September 2013 and stood at BDT 840 billion from BDT 600 billion in January 2014, according to Bangladesh Bank data.
Bangladesh Bank is in positive mood to approve foreign loan applications as the policy decision has positive implications on the domestic banking sector such as put pressure on banks to bring down the lending rate by raising competition. Big entrepreneurs are more interested in taking foreign loans as they can borrow at lower rates which are as low as 6.0 per cent. However, these entrepreneurs will become interested in taking loans in local currency if the trend of lowering the lending rates continues and the interest rate in the international capital market picks up with the US economy gaining momentum.  
COMPARISON OF BANGLADESH CAPITAL ACCOUNT REGIME WITH INDIA AND CHINA: Bangladesh's capital account transactions in terms of inflows are generally liberal for FDI inflows, portfolio equity investment inflows, portfolio bond investments. However, outflows of capital by residents for investment purpose -- be it for FDI, portfolio equity investments, and portfolio bond investments -- are not permitted. Foreign investors are not allowed to invest in Bangladesh money market and in financial derivatives. Resident Bangladeshi's are also not allowed to invest in money markets abroad and Authorised Dealers (ADs) are allowed in a very limited way to acquire hedging instruments abroad against exchange rate risk or price risk for commodities on behalf of their customers.
A review of the Indian and Chinese capital account control regimes however indicates much higher degree of openness, particularly in terms of outflows by the resident Indian and Chinese institutions and persons. Indian companies and registered partnerships may invest up to 400 per cent of their net worth abroad without approval. No limits apply for investment using funds earned in foreign currency or out of funds raised through ADRs/GDRs. Conditions may apply for unregistered partnerships and proprietorship firms. In the case of China, companies may purchase or transfer foreign exchange for outward FDI subject to registration only and can also use renminbi in countries that accept such settlement.
While there are some restrictions on what percentage of Indian and Chinese companies' shares may be purchased by foreign institutional investors (FIIs) or qualified FIIs (QFIIs in the case of China), investment by  qualified domestic institutional investors (QDIIs) in the case of China and by residents in the case of India are quite liberal. Resident corporations in India may invest up to 50 per cent of their net worth in shares of listed companies abroad. Indian mutual funds are permitted to invest abroad within an overall cap of US$7.0 billion.  In China, QDIIs' can invest abroad in portfolio bonds subject to overall ceilings and regulatory limits on the type of security. In India, only resident individuals may invest in debt securities abroad subject to a yearly limit of US$200,000. As regards investment in money market abroad, Indian residents may purchase instruments without Reserve Bank of India (RBI) approval following prescribed norms. Only QDII in China can invest abroad in money market instruments subject to their respective foreign exchange quotas and regulatory limits. Indian commercial banks and resident companies may purchase/use such derivatives for asset management or hedging against commodity price and foreign exchange debt exposures.
Private sector external borrowing from abroad is allowed liberally in India through automatic and approval routes. The borrowing limit under the automatic channel is US$20 million for loans up to three-year maturity and the limit is up to US$750 million for a minimum of 5-year maturity. However, external borrowings are subject to all-in-cost ceiling, which is adjusted automatically, and also subject to end-use restrictions. In China, private sector borrowing is subject to individual limits and subject to approval for maturities longer than one year.
In the case of Bangladesh, lending abroad by the residents is not allowed. In the case of India and China lending abroad are generally subject to approval, except for trade credit and lending to foreign subsidiaries. On repatriation of export proceeds, all three countries have repatriation requirements ranging from four months (Bangladesh) to one year (India). In China, export proceeds may be deposited in foreign exchange with domestic banks or abroad.  Depositing of proceeds abroad are regulated based on balance of payments and foreign exchange management needs.
The summary comparisons presented above indicate how much behind is Bangladesh compared to India and China. As a matter of fact, India started its liberalisation process in early 1990s as part of its broader economic transformation and moved quite speedily in the opening up process. Even during the recent economic and BOP (balance of payment) crisis, RBI and the Government of India did not impose very many restrictions and all of them have been withdrawn within a short time.

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