The hidden dangers of private foreign currency loans

Syed Ashraf Ali | Published: June 02, 2018 21:31:20 | Updated: June 02, 2018 22:20:12

An ominous trend witnessed in the last few years is the rat race for borrowing money in foreign currency by the borrowers in the private sector. According to the Bangladesh Bank's latest Annual Report (2016-17) the amount of foreign currency loans snowballed to a staggering $9.43 billion on June 30, 2017. It represents a hefty 28 per cent of the foreign exchange reserve of $33.49 billion on that date.

The potential risks implicit in these loans seem to have escaped everyone's radar-- in the Board of investment and the Bangladesh Bank, in particular. What is most disconcerting is their ambivalence, bordering on undue indulgence, to promote this rat race. Instead of raising cautionary signal number ten, Bangladesh Bank, for instance, in its last Annual Report, went on to eulogise the virtue of external commercial borrowing (ECB) as (i) a source of cheaper finance, (ii) creation of a competitive environment to induce the banks to reduce their lending rates, and (ii) the opportunity it provides to the central Bank to build up foreign exchange reserve.

 All the while, the borrowers, on their part, are blissfully ignorant of the grave risks they are carrying by exposing themselves to foreign exchange as well as interest rate risks. The illusion that set the trend for borrowing money from overseas sources had been fuelled by cheaper cost of money available from the overseas sources until very recently. It was reinforced by pegging the exchange rate of taka at an unrealistically overvalued level well up to 2017. Although the taka rate is said to be have been floated, its exchange rate is covertly dictated by the central bank through market interventions, a phenomenon known as 'managed floating'.  

In their quest for cheap money, the borrowers had been obviously blinded by short-term expediency. The potential exchange rate risks for repayment of these loans are not hedged through swap or forward cover arrangements as done by prudent business people all over the civilised world.  The underlying assumption - an erroneous assumption, to be sure -- was that the exchange rate of taka would remain stable over time. Another assumption - again, an erroneous one -- was that the gap between the domestic interest rates and those in the international loan market would continue to remain as wide as it had been.

In fact, the bubbles that have been built up over the years have already started to burst. According to a recent research paper titled "Private Commercial Borrowing from Foreign Sources in Bangladesh: An Anatomy" by the Bangladesh Institute of Bank Management (BIBM), the three-month LIBOR rate, which mostly remained below 1 per cent for the best part of last decade, hit a nine-year high of 2.32 per cent, meaning the local borrowers will have to pay about 2 percentage points more". The overall costs, the paper said, has risen to 6.25 per cent per annum. To these must be added hidden costs including cost of bank guarantee involved in borrowing from foreign sources. The story does not end there. The BIBM paper pointed out that the appreciation of dollar -- from Tk 78 to Tk 85 during the last one year -- has also created an additional pressure on borrowers.

These two-pronged pressures have wiped out what the borrowers thought would gain by their adventure into the bizarre world of international money and capital market.

The recent depreciation of taka has taken off some of the steams from the euphoria for collecting foreign currency loans. The exchange rate is still thought to be overvalued. There are tell-tale symptoms in the economy that warrant a quick depreciation of taka. The symptoms include sluggish growth of exports, widening balance of payments gaps, negative impacts on migrants' remittances, increasing trend of illicit fund transfers from the country and a great surge of people going overseas in quest of fun and frolic. Reality demands that we should not allow our currency to drift too far away from what we know as Purchasing Power Parity, at least in relation to our main competitors.      

Pakistan, one of our competitors, has allowed its currency to recede to around Rs. 115.60 a dollar from Rs.103.94 within the space of the last one year. Although in terms of economic growth, inflation rates and growth of external trade, India has outpaced Bangladesh, the exchange rate of taka vis-à-vis Indian Rupee since June 30, 2012 appreciated by about 21 per cent--from Tk 1.47 to Tk 1.22. It is no wonder that we are fast losing our competitive advantage to our neighbouring partners. The narrowing gap has also seen an avalanche of Indian goods entering Bangladesh through formal and informal channels with adverse impacts on our industrial enterprises and the farm sector.   

That means, sooner or later, the taka will have to be devalued to offset these impacts on our external trade and payments. In that event, the cost of repaying the foreign loans will become a pain in the neck for the borrowers. The East Asian countries that also fell into these types of debt traps in the nineties saw massive inflow of foreign money and its disturbing effects on the economy including a run on the foreign exchange reserve of countries like Malaysia and Thailand.

It is also too naïve to suggest that exposure to competition from international money market will force the banks to lower their lending rates. Bank's lending rates in Bangladesh, as elsewhere, are mainly influenced by the cost of funds, administrative costs and costs attributed to bad loans, euphemistically called 'nonperforming loans'. The cost of fund in Bangladesh tends to be high on account of stiff competition among the fast growing slew of banks and financial institutions scrambling for deposits. Another stumbling block is the alternative channel of investment kept ajar by the government through its Sanchayapatras. The ridiculously high yields of these saving instruments serve as a benchmark and define the limit up to which the bank can lower their deposit rates. To add salt to the injury, the ratio of non-performing loans has broken loose from its moorings on account of poor loan management accentuated by proliferation of loan scams. With these two strong deterrents working against them, the idea of forcing the banks, by way of exposure to external competition, to lower the lending rate is too farfetched. What this exposure is actually doing is driving away the relatively better creditworthy borrowers to overseas market leaving the banking sector to rub shoulders with the weaker segments of the borrowing entities.

Equally naïve is the perception that foreign loans provide an opportunity to build up foreign exchange reserve. On the contrary, it causes draining of foreign exchange with consequent negative impacts on the reserve. The arithmetic is simple. While the reserve funds employed by Bangladesh Bank with central banks and money markets abroad earn a mere peanut due to cheap money policy espoused by America following the financial meltdown a decade ago, the money borrowed by entrepreneurs in Bangladesh costs close to 7 per cent per annum denoting a net outgo of no less than 5 per cent per annum. It means that the amount of loans amounting to $9.43 billion at the end of FY17 would make the country poorer by nearly half a billion dollar every year, pretty close to the amount money swindled by Filipino hackers. In the final analysis, what is important for management of reserve is the net amount reserve after flushing out the artificial padding like foreign currency loans.

The present government has achieved spectacular success in terms of economic progress, improved social indicators, political stability, successful diplomatic manoeuvres and suppression of terrorism. It does not need to flaunt an artificially inflated reserve to woo the voters most of whom cannot distinguish between millions and billions. Neither does it need to showcase exchange rate rigidity as a selling point to the public who are too preoccupied with their own thoughts of who to vote on the basis of political leanings, religious and regional bias and other petty things like financial gains and affinity with those seeking public office. Exchange rate and foreign exchange reserve rarely feature in their thought process.  

This brings us to the question of how beneficial the private foreign loans are on our economy. The BIBM report notes that $18.67 million of the private foreign currency loans "has gone into the overdue position in February, up 83.58 percent year-on-year. The overdue amount, all of which is on the account of importers, poses a greater danger as they repay loans in foreign currency but they earn in local currency". The Bangladesh Bank's inspection team also detected at least 50 cases of misuse of loans where the borrowers used the money for repaying local debts or channelled these for other purposes. The seminar organised by the BIBM to discuss its research paper also noted that instead of using foreign loans for business purposes, many borrowers seem to service their local loans with the funds and that the overdue short-term foreign loan amount is increasing and heading towards default due to diversion of funds.

It is perhaps not too late to stem the rot arising from opening the flood gate for ECBs. Otherwise, the country will see its image tarnished on account of defaults of the bad borrowers, the problem ridden banks will be saddled with its obligations to compensate the overseas lenders against their guarantees and the borrowers will be thrown into wilderness. If, however, it is felt necessary to allow the private borrowers to borrow in foreign currency, it should be restricted to export oriented industries with funds provided from the existing Export Development Fund window. It may make a little dent in the reserve but, as explained above, will save millions of dollar unnecessarily gifted to foreign lenders.

Syed Ashraf Ali is a former central banker who also served a stint as chief of a commercial bank.

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