Foreign currency loans-- illusions and realities

The last few years witnessed a big rush - a mad rush, to be precise -- for foreign currency borrowings or what is known in the banking parlance as external commercial borrowings (ECB). The rush is fuelled mainly by prevailing low interest rates for foreign currency-denominated loans. The cumulative amount of these loans approved by the Board of Investment (BoI) during the last five years is reported to have crossed the threshold of $10 billion. These loans carry interest rates of up to 6.0 per cent per annum. 

In their quest for cheap money, the borrowers are obviously blinded by short-term expediency resulting from lower interest rates for ECBs. The potential exchange rate risks for repayment of these loans are not hedged through swap or forward cover arrangements.  The underlying assumption - an erroneous assumption, to be sure -- is that the exchange rate of taka will remain stable over time. Another assumption - again, an erroneous one -- is that the gap between the domestic interest rates and those in the international loan market will continue to remain as wide as they are now. With so many wrong assumptions influencing the decisions to borrow from overseas sources, the current euphoria for foreign money has all the trappings to turn into disaster, sooner or later.

We have had instances of roller coaster movement of exchange rates in the past and the predicaments of the borrowers who had contracted foreign currency loans from erstwhile Pakistan Industrial Credit and Investment Corporation (PICIC) and later from now-defunct Bangladesh Shilpa Rin Sangstha (BSRS). Most of the borrowers were unable to repay the loans due to escalating costs of dollar at the repayment stage. A scheme known as Exchange Rate Fluctuation Absorption scheme (EFAS) was rolled out to provide some relief to the borrowers. (This writer was a member of the committee that framed the scheme). The scheme, however, was of very little avail and the resultant loan defaults saw the demise of the lenders-BSRS. 

Of course, there would be many optimists among us who still harbour the illusion that taka will continue to hold its ground in the future as well. The reality is that there are tell-tale symptoms in the economy that warrant a quick revision of exchange rate of taka. Reality demands that we should not allow our currency to drift so far away from what we know as Purchasing Power Parity, at least in relation to our main competitors.        

It is worth pointing out that Pakistan, one of our competitors, has allowed its currency to recede to around Rs. 105 to a dollar while Sri Lanka, a relatively strong economy, had its currency, Sri Lanka Rupee, depreciated to as low as SR Rs 146 per US dollar. The gap between the exchange rate of taka and India, our most important trading partner, is narrowing fast. Since 2010-11 the exchange rate of Indian Rupee vs. taka has declined from Tk 1.66 to Tk. 1.18 - an appreciation of taka by about 29 per ent. It is no wonder that we are fast losing our competitive advantage to our neighbouring partners. The narrowing gap has also seen an avalanche of Indian goods filtering into Bangladesh through formal and informal channel. The farmers and industrial enterprises - smaller ones, in particular -- are groaning under the heavy weight of these avalanches.  

The 'robust' foreign exchange reserve could be one reason why authorities have refrained from adjusting the taka rate. Let us not forget that China, with a foreign exchange reserve of $ 3.19 trillion has not yielded to international pressure to appreciate its currency to sustain its export performance. India with a foreign exchange reserve of $ 353 billion combined with a robust growth of over 7.0 per cent and low inflation rate have consciously allowed its currency to slip to Rs.67 (from about IRs. 48 in 2009) to maintain its export competitiveness and improve the balance of payments. 

The ambitious high-profile projects envisaged in the budget and the spending spree, especially on burgeoning bureaucracy will inevitably cast their inflationary impacts on the economy. That means, sooner or later the taka will have to be devalued to offset these impacts on our external trade and payments. In that event, the cost of repaying the foreign loans will become a pain in the neck of the borrowers. 

The euphoria that is now seen in Bangladesh to contact foreign currency loans reminds us of the East Asian debacles of the nineties which saw massive inflow of foreign money and its disturbing effects on the economy including a run on the foreign exchange reserve of countries like Malaysia and Thailand. The sovereign debt crisis of the late seventies arising from massive inflow of foreign money in countries like Mexico, Brazil, Poland, etc. not only pushed the world economy on the brink of disaster but left behind a trail of bank failures across the continents. There are lessons to be learnt from these crises but unfortunately there are not many who, sitting on the ivory towers, are prepared to learn.  

The lesson that Thailand learnt, albeit too late, is that if you allow unfettered freedom to contract foreign loans, the borrowers who generally consist of influential people, will offer strong resistance against depreciating your currency even though it is warranted by economic reasons. The borrowers of foreign currency-denominated loans in Bangladesh too are generally big corporate houses enjoying strong political clouts. The proliferation of foreign currency loans will see them rallying against depreciating taka.  

Apart from foreign exchange risk, the borrowers assume interest rate risks by contracting foreign currency loans. Currently, interest rate in the international money market is low mainly because of the American cheap money policy to put back its economy on the track following the financial meltdown of 2007-08. The American Fed is now on course to raise its discount rate which will have profound impacts on the interest rate structure in the world money market. The rising interest rate will raise the cost of servicing the loans now being contracted by entities in Bangladesh. On the other hand, the interest rate in Bangladesh has come down significantly to around 10 per cent per annum. Because of the thin margin between the costs of borrowing from the domestic and international markets, the latter should no longer be seen as an attractive source especially when we factor in the exchange rate risks. 

It also seems unkind to drive away the relatively better creditworthy borrowers to overseas market leaving the banking sector to rub shoulders with the weaker segments of the borrowing entities with relatively poor credit ratings. The banks are loaded with surplus money and desperately looking for investment outlets by lowering interest rate. There are constraints to further lower the interest rates due to high cost of funds and high proportion of non-performing loans which has now escalated to as high as 515.70 billion (51,570 crore) across the entire banking sector by the end of last calendar year. There are constraints to further lowering interest rate on deposits. One is the competition among the large number of banks operating in the market. Another is high interest rate on government saving instruments that, one way or the other, serve as a bench mark for fixing interest rates by the banks. 

This brings us to the question of how beneficial the ECBs are on our economy. A newspaper report indicates that Bangladesh Bank's inspection team has detected at least 50 cases of misuse of loans where the borrowers used the money for repaying local debts or channelled these for other purposes. (50 cases of misusing foreign currency loans detected: Bangladesh Observer November 11, 2015).  The report also said that the borrowers provide false declaration to secure approval and sometimes pressure is exerted from influential quarters on the Board of Investment (BoI) to secure permission.

The following suggestions are made to improve the arrangement for ECB.

1. The facility for borrowing should be confined only to financing infrastructure and capital investment for export-oriented industries exporting at least 80 per cent of their products. 

2. To avoid speculative borrowings permission may be given for long-term loans. 

3. To avoid undue exposure, the banks should not be allowed to give guarantee; the lenders should rely on corporate or third-party guarantee. 

4. Like India, the borrowers should be encouraged to borrow from abroad in terms of taka so that the exchange risks are borne by the lenders. 

The writer is a former Executive 

director of Bangladesh Bank.

 saali40@yahoo.com