How a decline in short-term loans affects financial account

The country's banking sector has been experiencing higher repayment than borrowing of short-term external loans, leading the financial account to fall in deficit of nearly $4 billion in July-September period of the current fiscal year.

It has ultimately accelerated the depletion of foreign exchange reserves.

According to central bank data, the nation repaid $24 billion in short-term foreign loans in the first eight months of this year, roughly $5 billion more than it borrowed during the same period.

The total private sector external debt declined to $12.42 billion in September from $16 billion in December last year.

Money borrowed by private sector businesses and banks from external sources for the highest one year is considered short-term loans. Importers borrow from foreign lenders, mostly for purchasing capital machinery, which is known as buyer's credit — when banks take short-term trade loans from foreign sources to settle their external payments.

Short term loan is a component of the financial account which includes buyer's credit, deferred payment, back-to-back foreign letters of credit (LCs) and short-term trade loans.

Banks' borrowing from external sources was negative $2.7 billion in FY23 when it was $1.18 billion in FY22. The negative figure means that banks repaid more than they borrowed as foreign lenders are unwilling to offer fresh loans amid faster erosion of reserves and reducing repayment capacity of banks, said industry insiders.  

Bangladesh Bank data shows that short term external debt as a percentage of foreign exchange reserves surged to 65% in June meaning the country has to spend $65 for external payment against $100 in reserves when the ratio was 30% just two years back.

International economics guidelines state that a country's reserves should equal short-term external debt. Bangladesh's foreign exchange reserves came down to $19.52 billion on 23 November.

The declining reserves coverage of short-term external debt eroded confidence of foreign financers resulting in negative growth in short-term loans which are one of the major sources of foreign currency inflow to keep the financial account healthy.

Explaining the consequence of declining foreign exchange reserve coverage to short term debt, Dr Ahsan H Mansur, executive director of Policy Research Institute (PRI), said that it exposes the country's serious vulnerability of creditworthiness.

He said banks and businesses source short term loans from foreign private lenders which help to improve dollar liquidity and keep financial account surplus.

On the other hand, medium and long term loans are taken by the government and spent in government projects.

He said a surplus financial account is a must to rebuild reserves. The country's reserve crossed $45 billion last year which was due to a huge surplus in the financial account.

Bangladesh will have to repay net $12 billion in short term loans for which it needs $14 billion to $16 billion inflow to turn its financial account into surplus, he said.

However, inflow of short term loans has been declining due to problems in both demand and supply sides, said the economist who had a long career at the International Monetary Fund.

He explained that Bangladeshi banks and businesses are not willing to take short term loans due to rise in cost when foreign lenders are not willing to lend as reserve coverage of external debt is low.

At present, borrowing in taka is cheaper than dollar loans as lending rate is still low in the country. Moreover, there is depreciation risk. Previously, businesses were willing to borrow foreign loans as the local lending rates were higher than global rates. So, Bangladesh Bank should raise local lending rate to make money from local sources costlier as the country needs more foreign loans to increase dollar liquidity, Ahsan H Mansur suggested.

The economist said export and remittance cover the current account balance as import is low. But the country needs more short term loans to turn the financial account into surplus and enhance capacity to make other payments.

Lending rate in the banking sector is between 9% to 10.5% when foreign borrowing cost is above 12%, according to banking insiders.

Forex coverage to external debt halved to 24.8%

The country's foreign exchange reserve coverage of external debt almost halved in FY23 eroding confidence of foreign financers. 

Reserve to debt ratio is an indicator of how much foreign currency a country is setting aside for future needs and unexpected events.

Foreign exchange reserve to total external debt ratio is 24.8% meaning the country has $24 dollar against $100 loans when India's reserves cover above 92% of external debt.

Bangladesh's total external debt stood at $98.94 billion in June when gross foreign exchange reserve was $24.75 billion. With the reserves depleting below $20billion, the coverage ratio would be even lower at 19.8%.

Bangladesh Bank data shows that the reserves to external debt ratio was highest 73.70% in FY16 which came down to 44% in FY22.

However, Bangladesh still is in a good position in terms of debt-GDP ratio compared to most other countries. The total external debt to GDP ratio increased slightly to 21.80% in FY23 from 20.7% in FY22, Bangladesh Bank data shows.

The external debt to GDP ratio in South Asian countries averaged 86% in the last year, according to World Bank data.

Talking with The Business Standard, Zahid Hussain, former lead economist at World Bank's Dhaka office said that the ratio of reserve coverage to external debt is not considered in case of long term loans as multilateral donors come with funds during the crisis of a country. So, they don't consider the debt servicing indicator.

However, this indicator is important for short-term loans as the private sector borrows from private firms abroad. In this case, the declining foreign exchange reserve to external debt ratio will erode confidence of foreign sources of finance.

The country right now is hungry for dollar liquidity and more short-term loans can help to improve dollar availability. However, inflow of short term loans has been declining as diminishing reserves eroded confidence of foreign financers, he said. 

The former World Bank economist emphasized on improving dollar supply by removing barriers to remittance through legal channels and increasing exports and rebuilding confidence of foreign financers who lend to the private sector.