Private sector’s foreign borrowing reverses downward trend

Bangladesh, IMF

After more than a year of continuous decline, the private sector’s short-term foreign debt in Bangladesh experienced a notable turnaround in April 2024. According to data from the Bangladesh Bank, the private sector’s short-term foreign debts reached US$11.10 billion, up from US$11.04 billion in March. This US$60 million increase marks the first positive change since the beginning of 2023, providing a much-needed boost to the country’s foreign currency reserves.

The decline in foreign borrowing by the private sector commenced at the outset of 2023 and persisted into 2024. Several factors contributed to this downward trend, most notably the rising interest rates in international markets. As central banks around the world raised rates to combat inflation, borrowing costs surged, making foreign loans less attractive for Bangladeshi businesses.

However, a recent shift in monetary policies has changed the landscape. Central banks have started to cut rates or hold them steady following an easing of inflation pressures. This global trend has lowered the cost of borrowing internationally. In stark contrast, domestic lending rates in Bangladesh have surged sharply since the Bangladesh Bank (BB) deregulated loan pricing in a bid to combat stubbornly high inflation. This divergence has made foreign borrowing more appealing once again.

Local firms and businesses are now showing renewed interest in securing funds from international sources. Ahsan H. Mansur, executive director of the Policy Research Institute of Bangladesh, noted, “The turnaround is good news, and if the momentum persists, the pressure on the reserves will ease and it may go up eventually.” This shift is seen as a positive development, particularly for the nation’s foreign currency reserves, which have been under significant strain.

The improvement in foreign borrowing is also attributed to recent reforms in exchange rate management and interest rate policies. The introduction of the crawling peg system for exchange rate management and the move towards market-based interest rates have been widely credited for the uptick in US dollar borrowing. Prior to these changes, banks in Bangladesh set rates based on directives from the BB, and loans were capped at 9% between April 2020 and June 2022. The ceiling was gradually lifted starting in July, with a full market orientation achieved by May 8.

The impact of these changes on the broader economy is significant. If the central bank can effectively implement these reforms, the substantial deficit in the financial account could decline. Mansur, a former official of the International Monetary Fund (IMF), highlighted that a reduction in the financial account deficit would positively impact the country’s reserves. As of mid-June 2024, the reserves stood at US$19.21 billion, as per IMF calculations, which is less than half of the US$41 billion observed in August 2021.

The sharp decline in reserves has been a key factor contributing to the deepening deficit in the financial account, which encompasses liabilities to non-residents, including direct investments, portfolio investment, and reserve assets. Data from the BB shows that the deficit in the financial account reached $9.26 billion during the July-March period of the outgoing fiscal year. Notably, the reserves dropped by nearly $6 billion between January and May 2024, with the private sector accounting for a $4.5 billion decline, according to a study referenced by Mansur.

The global and domestic interest rate environment plays a crucial role in these dynamics. Previously, the interest rate for foreign loans ranged from 1 to 2 percent, but it has now risen to 8-9 percent. Conversely, domestic interest rates in Bangladesh, which were between 7 and 8 percent before June 2023, have climbed past 14 percent following the deregulation and could increase further. This disparity has made international borrowing more attractive for Bangladeshi firms.

In April 2024, short-term private sector borrowing from foreign sources increased by 5.45 percent, reaching US$1.88 billion, according to BB data. Although this figure is significantly lower than the levels observed in the past two years – US$25.79 billion in 2023 and US$37.25 billion in 2022 – it marks a positive change in trend.

The global monetary policy environment is also evolving favorably for Bangladesh. Central banks in major economies, including the European Central Bank, the Bank of Canada, the Swiss National Bank, and the Riksbank in Sweden, have reduced interest rates to lower borrowing costs. The US Federal Reserve is expected to follow suit, with anticipated rate cuts in September and later in the year. These developments are encouraging for countries like Bangladesh that have experienced capital outflows since late 2021.

By the end of December 2023, Bangladesh’s external debts surpassed US$100 billion, up from US$98 billion in June 2023. This rapid increase in foreign debt poses challenges, and experts emphasize the need for prudent resource management and sustainable economic development to reduce reliance on foreign borrowing. The depreciation of the local currency against the US dollar has further exacerbated the situation, making interest payments on foreign loans more expensive. As of May 2, 2024, Bangladesh’s gross foreign exchange reserves stood at US$19.9 billion, according to IMF guidelines.

Despite these challenges, there are positive signs on other fronts. Import payments for the July-February period of the financial year 2023-24 decreased by 15.36 percent compared to the same period in the previous financial year, reaching US$40.88 billion. This decline can be attributed to various government and central bank initiatives aimed at reducing imports, particularly of luxury goods.

The reversal in the private sector’s foreign borrowing trend is a welcome development for Bangladesh’s economy. If this momentum continues, it could help ease the pressure on foreign currency reserves and contribute to economic stability. However, careful management of foreign debt and continued economic reforms will be crucial to ensure sustainable growth and financial stability in the long term.

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