Will US, UK policy rate hikes cause pain in Bangladesh?

The United States and the United Kingdom continue to jack up their respective policy rates, but their battle to control prices is causing economic and financial pain in many developing economies around the world, including Bangladesh.

The strong dollar and pound put other currencies in a lose-lose: fight inflation along with slow growth, or allow prices to continue soaring.

Economists and bankers think that Bangladesh's export earnings, remittances, foreign direct investment (FDI) and trade finance would be affected owing to fallouts from the policy rate hikes.

Bangladesh debt servicing will also become costly with a further rise in floating interest rates, they add.

The US Federal Reserve on Wednesday announced its fourth consecutive 75 basis point interest rate hike, which took the benchmark lending rate to the range of 3.75% to 4%. A day later on Thursday, Bank of England raised its benchmark rate by 75 basis points to 3%, its biggest hike in 33 years. It was the eighth consecutive hike to the main lending rate.

Economists say generally, when a country follows a contractionary monetary policy to control inflation, it raises the policy rate, which makes the currency costly and increases interest on loans. Another purpose of raising policy rates is to discourage people from taking out loans and force them to cut spending. 

If borrowing falls, so will investment and employment. Besides, the people's purchasing power will also decrease. As a result, they will buy less goods and reduce expenses, leading to an economic slowdown, they point out.

Zahid Hussain, former lead economist at the World Bank's Dhaka office, said the dollar price may not increase much due to the US and UK interest rate hikes. "But this rate may affect FDI inflows," he noted.

Bangladesh's FDI growth stood at over 37% year-on-year at the end of FY22. The economist believes that this growth may decrease slightly because the two countries hiked policy rates.

Besides, it is natural that people will reduce their spending when their purchasing power decreases due to contractionary policies. As a result, Bangladesh's export sector will suffer a blow, Zahid Hussain noted.

Md Shahidullah Azim, vice-president of Bangladesh Garment Manufacturers and Exporters Association, said, "The US policy rate hike will add to our falling exports to the market because of soaring inflation." 

Foreign debt interest rates to go up

Bangladesh's gross external debt stood at $95.86 billion in FY22, of which around 70% went to the public sector. 

A sizable portion of Bangladesh's external debts is received at variable interest rates – meaning the interest rates on these loans are adjusted with the interest rate prevailing in the market after a certain period. If the interest rate increases in the international market, the interest rates on these loans also go up.

Zahid Hussain said a number of loans from the Asian Infrastructure Investment Bank and Asian Development Bank are at variable interest rates. Hence, the country's economy will face additional interest pressure in the case of renewing these loans, he added.

Likely blow to remittance inflows

Bank of England Governor Andrew Bailey has warned that his country could be in a record-long recession for the next two years. This could push the UK unemployment rate past the current 6.5%, the lowest in 50 years.

Zahid Hussain feels that an increase in unemployment rates in the U would make a dent in Bangladesh's remittance receipts.

"A large portion of remittances from the UK is sent by Bangladeshi businessmen who run various businesses including restaurants and hotels in the country. So, if there is a recession there, the income of these people will also decrease. Many people may lose their jobs because of that. As a result, remittances may decrease," he explained.

But the remittances that come from the USA include remittances from many countries in Europe, he mentioned, adding that the money sent by Bangladeshi nationals living in several countries comes through the US. Therefore, remittances coming from the USA will not be affected much, he added.

Arfan Ali, former managing director of Bank Asia, told TBS that due to an increase in policy rates in the USA and UK, investment by expatriates living in those countries in various saving tools in Bangladesh, such as wage earner's bonds, may decrease. Many people may be demotivated to keep deposits in Bangladesh due to the falling value of taka against the US dollar.

He also said that it will be good for the country if incentives on remittances can be increased.

"We also need to wage some publicity campaigns. Not many people know that remittance is tax-free in our country. Remittance inflows will increase if this type of campaigns can be increased."

Interest expenses to spike up

Zahid Hussain said if the Fed's interest rate increases, the Secured Overnight Financing Rate (SOFR) will increase.

He said, "Our banks take short-term loans from foreign banks, and the interest rate of these loans is determined based on the SOFR rate."

"When the Fed rate rises, the SOFR rate rises too. As a result, our borrowing will also become costly as the interest rate increases. As a result, these loans which are under trade finance may decrease."

The SOFR, is an influential interest rate that banks use to price US dollar-denominated derivatives and loans.

Noting that LC confirmation charges in Bangladesh are also increasing due to the country's current risk rating, he said, "We are unable to settle LC payments on time. Many banks have to defer payments because they do not have enough dollars in their hands. For all these reasons, foreign banks are demanding more confirmation charges."

Banks are now going through a crisis of dollars. When asked how a surge in dollar demands at this moment would impact the banking industry Arfan Ali said, "Our dollar borrowing cost will increase. A large part of the import LCs being opened from our country is being deferred for six months to one year. Interest rates on these deferred LC dollars will increase. New interest rates will be charged at the time of renewal. As a result, our interest expenses will increase, and more dollars will go out of the country."

This will also reduce the country's imports to some extent, he continued.

The seasoned banker stressed strengthening the country's export competitiveness in this situation.

"Our internal consumption and growth are good, but there will be some pressure on the external trade. Besides, if our import dependency can be reduced somehow, that will also be good for us. At the same time, we have to go for cost reduction."

For the time being, it would be better to slow down the large projects that are mostly dependent on imported materials, he suggested.