Impacts of high cost for external borrowing on the economy

 

External borrowing in foreign currency was cheaper, once, compared to local borrowing. Resident corporates were eager to access to external borrowing. External lenders started focusing on Bangladesh in first decade of the current century. There are two types of external borrowings - trade credit up to one year and commercial borrowing beyond one year.

Bangladesh is the birth place of back to back letters of credit (LCs). This is born in late eighties of the last century. During the first decade of this current century, another trade product is born, known as UPAS LCs. The acronym denotes usance payment at sight meaning that importers will make payments at the date on expiry of credit period, but suppliers will receive payments in the same way as sight import bills are paid. The usance period needs to bear cost. This is a modified version of buyer’s credit; lenders make payments to suppliers abroad based on import bills accepted by LC issuing banks. UPAS LCs work as trade credit.

Trade credit from external sources is generally permitted for specified products with a maximum tenure of one year, no specific permission is necessary. This is continuing for more than a decade. The annual interest rate for the program initially was capped at 6 percent. Later, it was tagged with 6 month LIBOR plus 3.5 percent per annum. With the phase out of LIBOR, all-in-cost was replaced by SOFR (secured overnight financing rate) plus 3.5 percent per annum. Due to rate hike of Fed (US central bank), SOFR becomes costly, resulting in all-in-cost for trade credit exceeding 8 percent annually. Before April of 2020, cost for Taka borrowing was in double digit. The authority capped lending rate at 9 percent. Besides risk associated with exchange loss., external borrowing presently is costlier in terms of interest rate compared to cost in Taka borrowing.

Commercial borrowing from external sources is for more than one year. Since Taka is not convertible on capital account transactions, commercial borrowing is subject to approval from competent authorities. Just a few years back, commercial borrowing was very cost effective with respect to its interest rate and little risk in exchange loss. The borrowing pending for repayment faced huge loss due to Taka depreciation to a large extent. This loss is basically faced by borrowers having no income in foreign currency. Insider information indicates that external borrowing at cheap rate was also sourced to wash out local borrowing. Foreign borrowing is generally allowed by authorities concerned to meet external liabilities on account of imports of capital machinery in particular. The interest for foreign currency particularly high cost for US dollar makes external borrowing costlier compared to borrowing cost in Taka.

Foreign exchange market brings foreign currency on account of exports and different inflows like factor payments, transfer payments, etc. The inflows are used for settlement of external obligations without limiting to import payments. As said earlier, UPAS LCs support to import goods on credit at the cost of importers in the same was as buyer’s credits do. Everyday import is executed on terms - sight and credit. During the day, banks make payments of sight bills and matured import bills against imports under credit. This composite position keeps foreign exchange market eased. But what to happen in case of all imports executed on sight is a matter of analysis. Without analysis, it can easily be guessed that market will face pressure due to current payments along with previous repayments against matured bills.

As we know that global economy faced negative impacts due to Covid, and Russia-Ukraine war. This results in supply chain disruption leading to global price hike. Bangladesh economy, as a result, fell in trouble to manage external sector in meeting payment obligations. To contain the troubles, authorities concerned took different measures such as imposition of margin against imports, deferral of import payments, monitoring of high value imports, and many more. Very recently central bank waived the margin requirement for 8 importable items - edible oil, chickpea, pulse, pea, onion, spices, sugar and date. These items are also permitted to import for a credit period of 90 days under supplier’s/buyer’s credit. The items are imported commercially, meaning that finished goods are imported for resale. Central bank allows importers to import them on credit terms. Foreign suppliers and external lenders may not support the transactions other than UPAS LC model. Insider information shows that importers are reluctant to import under UPAS LCs for the ground of higher cost against foreign currency loan and expectation of adverse movement of exchange rate.

As said earlier, external borrowing becomes costlier. Importers, in this situation, prefer imports on sight basis without availing trade credit particularly in the form of UPAS LCs and buyer’s credit. But banks cannot manage to execute transactions in sight terms. Banks seem facing double impacts - repayment obligations against previous trade credit and current sight payments. Bangladesh, by way of resourceful demographic composition, is on right track to run the economic activities in producing outputs. The activities require input contents which need to be imported. During the last decade, import substitution industries are developed to a new height. With the path-showing by readymade garment industries, new windows are created in export sector. Both import substitution industries and export sector are dependent on input contents. Reasonable cost of external borrowing supported a lot to flourish these sectors. But these are facing negative impacts due to price hike in external borrowing.

Economic activities are a dynamic process until demographic composition remains favorable. On being graduated to developed stage, growth momentum may become steady. Bangladesh economy is moving to reach the height of development for which external borrowing is required.

There needs a win-win situation so that economic activities can move forward. General authorization of trade credit from external sources can work when the cost is reasonable compared to the same prevailing in the domestic market. Otherwise, liquidity support becomes inevitable, for which initiatives are required to encourage inflows from all sources without limiting to different incomes and wage remittances. In this context, exchange rate for wage remittances should be made market driven, which may be higher compared to capped rate. Inflows from wage remittances can be used for payments of non-essential imports and for different services and factor payments. Exchange rate for export and other sources excluding wage remittances may be continuing, for the time being, as set by bankers’ associations.   This proceeds should be sold with a prescribed mark-up for industrial and essential imports. The rate  being comparatively lower than that of wage remittances can retain local commodity prices at a reasonable level. The proposition of market driven exchange rate for wage remittances can enhance market liquidity in foreign currency to support the incremental requirements created due to high external borrowing cost. In addition, sourcing of non-commodity concessional loans in foreign currency may be an alternative to keep external activities buoyant.


Mehdi Rahman works in the development sector.