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Monetary matters

Forrest Cookson | April 19, 2018 00:00:00


What do we know about the Bangladesh economy: gross domestic product (GDP) is growing rapidly at 7.65 per cent; there is full employment by the usual measures; inflation remains high at 5.5-6 per cent; the balance of payments is shifting into deficit with rapidly growing imports [25.20 per cent for seven months compared with 9.0 per cent the same period in the previous year; along with moderate growth of exports [7.14 per cent for eight months up from 2.7 per cent] and strong remittance growth [17.0 per cent for nine months compared with -16.8 per cent]; the current account for calendar year 2016 was a surplus of $1.87 billion and for 2017 it was in deficit by $5.31 billion, a swing of $7.18 billion. Foreign Direct Investment remains low. Money supply is growing at an annual rate of about 5.3 per cent compared with 6.9 per cent for the previous year for the first eight months; private credit is increasing at an annual rate 17.1 per cent compared to 12.9 per cent. This reflects the Government shifting its deficit financing to the National Savings instruments and slow decline of foreign exchange reserves. Deposit rates have risen accompanied by higher lending rates.

In the banking system non-performing loans have increased. The public accusations in Parliament against the Farmers Bank triggered a run on that bank borrowers refused to repay loans and depositors withdrew funds. For perhaps 20 of the weakest private banks the effect was immediate, deposits growth declined, loan recovery worsened. This reduced the ability to lend, moved many banks towards a position of inadequate capital. Foreign banks are refusing to do business with the weak banks further harming their earnings through reduced fees.

Fiscal policy remains conservative with the deficit/GDP ratio low. Foreign debt is low. However, borrowing from abroad by private companies has increased in recent years and these companies are exposed to difficulty if the Taka depreciates further.

The authorities are faced with a dilemma: For the next 18 months the current account of the balance of payments will show growing deficits. This will put pressure on the exchange rate. Unless the authorities intervene to the tune of several billion dollars selling dollars from the reserves to keep the Taka strong the Taka is likely to depreciate substantially. To maintain a high GDP growth rate will require either a depreciation of the currency or use of a significant amount of reserves. The objective must be to increase the volume of exports to reduce the current account deficit to a manageable level. It is necessary to use the next two years to make real improvements in the factors that limit export growth. If export growth cannot be accelerated it is necessary to slow down the increase of imports and hence also reduce the GDP growth rate. Alternatives such as limiting imports by administrative measures will not be successful, rather such measures will increase corruption and slow down the private sector's ability to make investment decisions on the merits. Efforts to replace private sector activity by government enterprises would be equally disastrous.

The difficulty with the depreciation of the currency is that it increases inflation. But the use of reserves to limit depreciation does not lead to the kind of change necessary to increase export competitiveness. For a given target of economic growth the central bank can control the exchange rate or the level of reserves but not both.

The changes in interest rates in the past few weeks pose another dilemma. First, the central bank cannot really control the interest rates. The deposit rates are influenced by the high interest rates of the National Savings Instruments. Deposit growth slowed, apparently as a result of withdrawals and no fresh deposits from a number of banks. To attract deposits banks began to raise deposit rates and of course then had to increase lending rates. Higher lending rates were trouble for borrowers; rates are already fairly high and increases of 2-3 per cent would cause difficulty in the loan repayment. Among other effects this would cause profits to decline, less taxes paid to the government and reduced investments by the commercial banks in the stock markets. Falling bank stock prices from lower earning along with less support for the market from commercial banks would together tend to drive down prices on the share market.

As a result of all of this the country is faced with a number of private banks that are weak in the sense that they are exposed to withdrawals of deposits, have rising NPLs and face difficulty in meeting their capital adequacy requirements. What should Bangladesh Bank (BB) do in this situation?

One line of argument that has come from many economists is that the central bank should be tough and not come to the rescue of these troubled banks. This line of thought claims that if these weak banks are lent money by the central bank they will waste it with bad loans; the central bank will not be able to keep the banks from lending. Many economists speak as if they want to punish groups that they perceive as wrongdoers. The difficulty is that the financial system would be severely harmed by the failure of a number of private banks; this would accelerate bank runs and shifts of deposits into the state banks. The shifting of funds may move up to middle tier private banks that are not in bad shape. Much of the private banking sector banking sector would be weakened and that would lead to a sharp slow down of the economy, back to the 1980s.

There is a different view. The central bank's first responsibility is to keep the banking system functioning. This is more important than punishing banks or persons for wrong doing. This was the dilemma that faced the Federal Reserve system in 2008 when Lehman Brothers collapsed. The Fed let this happen and then the world caved in on them. There was plenty of wrong-doing throughout the American banking system; widespread fraud in mortgage lending; misrepresenting of the actual situation to depositors, investors, and the authorities. Then the Federal Reserve realised their mistake and went on to flood the financial sector with money- first one saved the financial and banking system and then work on fixing it later. Painful but more or less successful.

Bangladesh Bank (BB) faces the same problem. Allowing the problems at The Farmers Bank to surface unresolved triggered the events that are now before the authorities. The attempts by BB to tighten monetary policy as outlined in the Monetary Policy Statement for January to July 2018 was probably a wrong move, given the weakening of a significant number of private banks.

Instead, as the authorities became aware of the difficulties facing a number of private banks they changed course rapidly: Lowering the Cash Reserve Ratio (CRR), allowing government agencies to spread more deposits into the private banks, postponing the reduction of advance-deposit ratio (ADR), and allowing more deviations from meeting capital adequacy requirements were certainly the right first steps.

However, it is urgent for BB to order these weak banks to cease lending, to build up their capital, focus on collection of existing loans and to increase holding of government securities. BB should provide its own debt instruments if government cannot to enable the weak banks to build up liquid instruments to hold as assets. In this way BB can stabilise the weak private banks. If these weak banks are allowed to continue to lend to the private sector their condition will only get worse. Of course, there should be some punishment and any bank that does not meet its full provision requirements and is unable to reach capital adequacy should not be allowed to issue dividends of any sort or to pay bonuses to senior officers.

Those economists calling for a tough line by BB against the weak banks are wrong. BB must first insure that the banking system does not get into further difficulty, rebuild public confidence and gradually untangle the problem these weak banks face.

The writer is an economist.

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