Dilemma with interest rate

Bangladesh Bank on August 8, 2021 embarked on a soothing strategy to make interest rate on fixed term deposit of three months or above higher than the average inflation of three months. When interest rate on deposit is less than the inflation, the depositor loses the real worth of the deposit. Thus the deposit interest rate may hover above 5.30 percent; the average of three months inflation. The recent drive on fixing interest rate on deposit higher than the inflation rate would help depositors who depends on accrued interest income on deposit for sustenance. The category of deposits include personal deposits, provident fund or pension fund of government and non-government institutions. The market determined interest rates are now substituted by fiat to create an enabling environment for investment as single digit interest rate on lending enhances the profit margin with a higher rate of return on investment.

One of the goals initiated in 2019 and continued till the just announced monetary policy was to set the interest rate both on lending and deposit at a single digit (9 percent on lending and 6 percent on deposit) with spread at 3 percent though variation in spread between state-owned commercials banks and private commercial banks may differ by one percent margin: 2.13 percent to 3.13 percent. The spread is highest in the foreign commercial banks (5 percent) who often collect fund from abroad and the lowest is with the specialized banks; less than 2 percent. The interest rate spread widened significantly in May, 2021 as the banks cut their deposit rates further while lending rates remained unchanged. The weighted average interest rate on deposits fell to 4.14 per cent in May 2021 from 4.36 per cent in the previous month while such rate on lending remained unchanged at 7.40 per cent. There are now about 10 scheduled private banks who have to increase the interest on fixed deposit by a margin of over 2 percent and 10 scheduled private banks to increase the interest on fixed deposit by a margin in the threshold of over 1 percent. State owned commercial banks adhered to the rate stipulated by the Central Bank though a few private commercial banks with weak market fundamentals increased the deposit interest rate.

With excess liquidity accumulating on the increased remittance flow during the last years and a lull in consumption, many private banks forced to lower the lending rate as COVID-19 pandemic put a slur on investment and thus in tandem on deposit rate at 2.5 to 4.0 to maintain spread at the threshold level of 3 percent. The private sector credit growth came down to 7.55 per cent year-on-year in May, 2021 from 8.29 per cent a month before because of the second wave of the Covid-19 pandemic and business with a “go-slow” strategy may further observe a falling trend to counter plausible risks. Banks are also cautious in sanctioning loans to borrowers given the business slowdowns, contributing a heap up of excess liquidity in their balance sheets.

There are both merits and demerits on fixing interest rates at a higher or lower level. This depends on the various determinants related to the profitability of the bank, health of the economy, liquidity position of the bank, expected inflation in the economy, extent of fiscal deficit, percentage of NPL and interest rate applicable to other treasury bonds or other savings instruments. Excess liquidity at USD 27, 177 million (Tk.231, 0000 million) as of June 30, 2021 manifests that a conducible environment in investment is yet to happen. Unless there are concerted efforts on the part of Bangladesh Bank, this excess liquidity may augur creeping inflation through the conduit of fiat interest rate on deposit.

One option may be the slashing of the cash incentive currently at the rate of 2 percent of remittances flow. The current reserve position to the tune of over USD 42 billion is comfortable on many counts; stability of per value of Taka with USD and the number of months in terms of annual import. The fabulous growth and transaction in the DSE during (August 8, 2021- August 12, 2021) of USD 1295 million is an indication that remittances flow is fuelling the excess liquidity and without any productive investment, this excess liquidity is causing asset bubble in the capital market. The remittance in most cases is being translated into portfolio investment by expatriates with the expectation that it would earn a higher return or appreciate in value over time. Again as interest rate is higher in Bangladesh from the near zero percent rate in developed nations and there is an added incentives in the conversion of Taka into USD with stickiness in the exchange rate, there may be glut of remittance flow in immediate near future accentuating the excess liquidity position of the scheduled banks. Bangladesh Bank may initiate an exploratory study to identify the various channels on remittances uses. It is encouraging to note that Bangladesh Bank has lately issued instructions to scheduled Banks to submit report on the use of funds on a daily basis instead of fortnightly basis.

The second option relates to careful scrutiny of the trend of operating profits because despite disruptions caused by the ongoing Covid-19 pandemic, many scheduled banks have seen a rise in operating profits egged on lower interest rate on deposits and sticking to lending rates. The third option is to carefully monitor the disbursement of stimulus package; stimulus package is designed to boost effective demand that would create congenial environment for growth adversely squeezed by the pandemic. Nevertheless, there are grievances among the workers in irregular payments of salary and benefits in many manufacturing units. Even there are reports of lay off of the workers in manufacturing units and investment in stocks with stimulus package.

Another option is to mop up funds from the market through Bangladesh Bank Bill or reverse repo; a preferred option for banks. Bangladesh Bank may go for that option in the face of urgency when the delicate link between deposit interest rate and inflation are tenuous to make real interest rate positive.

The Association of Bankers in Bangladesh urged the Bangladesh bank to review the cap on deposit interest rate in consideration of the current pandemic situation but Bangladesh Bank is firm on its stance to protect the interest of depositors to make real interest rate positive.

The writer is the Treasurer and a Professor, School of Business and Economics, United International University.