There is widespread allegation from the business community that bank interest rates and charges in Bangladesh are too high. They also feel that the current weakness in the domestic economy is in part attributable to high interest rates which have adversely impacted investment and domestic economic activity.
This is an important national policy issue and will require careful review of many related aspects of the Bangladesh economy before making an informed policy decision in this regard. We all would like to see the lending rates to come down, but it must not be engineered by administrative interventions and has to be market-based and sustainable.
In the preceding decade (fiscal year or FY 2002-13, - FY 2012-13), with inflation rate increasing, the average real deposit rate became negative (-0.72%) and the real borrowing rate averaged at 4.53%. As the inflation rate decelerated in FY13, the average deposit rate became marginally positive (1.5%) and the real borrowing rate increased to 6.0 per cent. The spread between lending and deposit rate, however, declined modestly in FY 13 to 5.3 percentage points.
The narrowing of spread however reversed and the spread started to widen in FY14 in part due to the effect of growing nonperforming loans.
Based on the historical observations questions may arise whether Bangladesh's real interest rate is out of line with many of its comparator countries. A comparison with other countries indicates that, while the average real lending rate of Bangladesh is high, a number of regional countries like Indonesia and Thailand are also experiencing high real borrowing rates.
Meanwhile, administrative costs of banks such as operating expenses, excluding interest cost, are generally a component of the spread - the difference between lending and borrowing rates the country's commercial banks' operating costs excluding interest payments on deposits generally ranges between 0.7% of its asset base for state owned commercial banks to 1.4% for foreign commercial banks. Although not very high, when compared with countries with more efficient financial system and lower spread, there is scope for some improvement in this area. Overinvestment in office buildings and furnishings has increased administrative costs.
THE EXCHANGE RATE DILEMMA: In its latest Monetary Policy Statement (MPS, January-June 2014), Bangladesh Bank (BB) aimed to preserve external sector stability, building up reserves and avoiding excessive volatility of the exchange rate. In the event, improved external balances have been reflected in further building up of international reserves by US$2.8 billion in the second half of FY14 with gross reserves increasing to US$21.6 billion at the end of June 2014, sufficient to cover more than six months of projected imports.
However, large surpluses in the external current accounts and the overall balance of the balance of payments (BOP) in recent years have led to an oversupply of dollars in the foreign exchange market and the exchange rate would have appreciated significantly in nominal terms against the US dollar unless BB continued to absorb the excess dollars from the market to maintain exchange rate stability in nominal terms.
The main imperative for such an intervention was to protect the competitiveness of Bangladeshi exports in an environment when exporters faced demand compression in the industrial countries due to the European debt crisis and a falling export receipts in recent months as the country's readymade garments (RMG) sector is yet to come out of the fallout from the Rana Plaza disaster.
BB's stance on preventing an appreciation of the nominal exchange rate is understandable because in addition to the factors described above, the export sector also passed through a difficult situation due to the intensified political disturbances in the second half of 2013, industrial unrests in the RMG sector, and wage pressures.
The prolonged and sizable exchange market intervention by BB complicated monetary management through injection of liquidity into the system. In order to adhere to the inflation objective under the MPS and the underlying monetary targets, BB had to mop up the excess liquidity by issuing BB bonds at appropriate market interest rates.
This mopping-up operation helped contain expansion of monetary targets and all key monetary indicators were within the targets set under the MPS of BB. The restrained monetary policy has helped BB to bring down inflation significantly in recent months, although it missed the inflation target by a relatively modest margin. At the same time, the quasi-fiscal cost associated with the sterilization operation eroded BB's profitability since it earns much less on its foreign assets compared with what it pays on its domestic liabilities (such as BB bonds).
This tension between the exchange rate management and monetary management would continue until domestic demand remains subdued causing slower growth in import payments. Once domestic economic activity and investment start to rebound, growth in import payments will accelerate, and there will be no need for monetary intervention or sterilisation. This may start happening with import payments increasing with the financing for the Padma Bridge.
The other interesting part of exchange rate management was that while BB was successful in keeping the exchange rate of the Taka very stable against the dollar, the Real Effective Exchange Rate (REER) of Taka appreciated significantly, eroding the competitiveness of exporters. The relatively high domestic rate of inflation, compared with the inflation rates of Bangladesh's trading partners, has contributed to the appreciation of the REER of Bangladesh Taka and erosion of export competitiveness.
BB's own calculation indicates that the REER index of Taka appreciated from below 89 in FY11 to more than 106 in FY14, entailing more than 19% erosion of export competitiveness. Certainly, this situation is not sustainable and something must change: (i) either domestic demand must pick up through higher investment and consumption to depreciate the Taka in the interbank market; and/or (ii) the rate of inflation must come down sharply to levels broadly in line with Bangladesh's trading partners.
Certainly, the policy of keeping the nominal exchange rate virtually fixed while the inflation rate is much higher than its trading partners is not working and it is not sustainable for long.
LIBERALISATION OF FOREIGN CURRENCY DENOMINATED BORROWING BY THE PRIVATE SECTOR: After a long period of virtual prohibition on borrowing from international market by the domestic private sector, BB in recent years has started to shift its policy. 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 BB, 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.
In the past six years, BB has allowed private firms to borrow $5.56 billion from foreign sources at lower interest rates of around 5.0%-6.0%. In its monetary policy for July-December FY15, BB has set the private sector indicative credit growth at 16.5 per cent for the second half of the year, with 2.5 percentage points of that coming from foreign borrowing.
Borrowing in foreign currency is not something new for a country like Bangladesh. In fact most countries in the region including India, China, Viet Nam and others have much more liberalised approach to foreign borrowing by the domestic private sector. Despite the shock experienced at the time of Asian Economic Crisis of 1990s, most East Asian countries have come back to liberalized foreign borrowing to enable the private sector to get financing at competitive interest rates.
For Bangladesh the journey has just started and hence a number of issues are being raised about its appropriateness, timing, sustainability etc.
 The total loan approved for the private sector in Bangladesh has been increasing consistently from 2009 onwards. The amount of total approved loans increased from $0.412 million in 2009, to $1.55 billion in 2013, which was an increase of 277%. From 2011 onwards, the approval process for loans has increased significantly which indicates that BB is actively trying to open up foreign financing sources for the private sector.
A sectoral classification of the foreign loan portfolio of the private sector from 2009-2014 shows that the sector that received the highest amount was the telecommunication/ internet service provider (ISP) sector which accounted for 42.6% of the total. The second and third highest loan amounts was received by the Power and RMG/related products sector, which accounted for 18.6% and 12.5% of the cumulative loans for the period, respectively.
The highest recipient of foreign loans, the telecommunication/ISP sector, is exposed to relatively low risk due to most of them being parented by large international conglomerates. In comparison, most of the power sector and RMG sector projects are owned domestically.
A survey report of BB states that these loans were mostly been used for importing foreign capital machineries, expansion of existing projects and establishing new ones. The survey pointed to three major potential/actual difficulties in external borrowing:
l 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.
l Borrowing from off-shore banking unit: 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.
l Lengthy procedures for loan approval: The loan application and approval process takes considerable time, which acts as a hindrance for some companies which require financing urgently.
More tomorrow. Dr. Ahsan Mansur is Executive Director, Policy Research Institute, Bangladesh.
ahsanmansur@gmail.com