How tax on foreign loan interest hurts businesses, banks

Infographic: TBS

For one of the largest commodity traders in the country, the offshore banking unit (branch that offers loans in dollars) of his bank was a blessing. It could get quick dollar support for imports at a good rate – the last time being 8%.

But recently the commodity importer had to pause. Global interest rate has been on the rise and a 20% "withholding tax" imposed in the current budget on interest payment has made foreign loans costlier further. The cost of borrowing has now shot up to around 11%.

The importer asked his bank to arrange dollars from the local market instead for payment of import bills.

"As he was one of our valued customers, we tried our best to arrange dollars from the market for him. Yet, we could not arrange the required amount – $10 million," said a frustrated treasury banker.

This is how businesses are suffering from the imposition of the tax on interest payments for foreign borrowings from 1 July this year. Analysts and bankers predict that this measure will significantly impede the growth of the industrial sector within the country, given that entrepreneurs have relied on these cost-effective loans to fuel their business expansions.

For instance, DBL Group, which is one of Bangladesh's leading textile and apparel manufacturers and exporters, used to take foreign currency loans directly from international development finance institutions, such as the International Finance Corporation (IFC), British International Investment, and some other organisations.

The group that borrowed $96 million from international development finance institutions last year is now feeling discouraged in availing this kind of loans anymore.

"It seems we are penalised for being compliant and disciplined," said MA Jabbar, managing director of DBL Group. "For getting loans from international development finance institutions, we had to invest to ensure compliance."

A senior official of a private bank said foreign loans are more important now than any time before to keep the economy going. He said banks will ultimately have to provide dollars if they want to import with a loan in taka. On the other hand, if the loan is available in dollars, the import expenses can be settled directly from there. As a result, the pressure on the supply of dollars in banks is reduced.

It seems we are penalised for being compliant and disciplined. For getting loans from international development finance institutions, we had to invest to ensure compliance -- [MA Jabbar, Managing Director, DBL Group]

Due to the new taxation policy, the cost of dollar loans will increase significantly.

Former senior official of the International Monetary Fund (IMF) Ahsan H Mansur told The Business Standard that such a policy should be made after detailed study. The government could have announced this year that tax will be imposed on the foreign loans from next year, he said. If this was done, businessmen and banks would get time to pay the loan. Now, they will suffer due to the sudden taxation. The loans taken before this policy are also taxed, he said.

Countries that have double taxation avoidance agreements with Bangladesh may get some relaxation, meaning they have to be informed in advance when imposing taxes. But the loan taken from the rest of the countries will have an adverse effect, he said.

How the tax measure pushes up costs

The interest rates in the international market are now linked to the Secured Overnight Financing Rate (SOFR) instead of the formerly LIBOR. Foreign loans are subject to an added interest (margin) of up to 3.5%.

In light of the US Federal Reserve's policy rate increase, the SOFR already surged to 5.35% from as low as 0.25% during the Covid-19 pandemic and below 1% even in early 2022. Consequently, the interest rates for loans on the international market have experienced a corresponding spike.

Bankers have said an individual availing a $2 million loan through buyer's credit or from an offshore banking unit for a one-year term would incur approximately $180,000 in interest. Under the new withholding tax on interest payments, businesspersons would be liable to pay around Tk39 lakh in taxes on interest payment. While foreign companies are obligated to cover this tax, they typically pass on the burden to borrowers. Also, loans obtained five years ago, if repaid with accumulated interest, would also attract taxes under the new guidelines.

Prior to the imposition of this tax, a Bangladeshi customer securing a loan from an international lender would have faced a maximum interest rate of 8%, compared to at least 9% for local loans. Presently, obtaining a dollar-denominated loan from overseas translates to an interest rate of nearly 11%, surpassing the 10.10% interest rate for local loans.

Bankers said the NBR introduced this tax, which will discourage borrowing in dollars. Any reduction in foreign loans due to the added taxes could potentially erode the nation's foreign exchange reserves, now at $23.3 billion, they warned.

According to data from the central bank, as of March this year the foreign debt owed by the private sector surpasses $22 billion, of which $13.66 billion is short-term. The outstanding short-term loan amount through offshore banking units was $2.92 billion at the end of June this year, Bangladesh Bank data shows.

Businesses' worries

With more expensive foreign loans and trade finance facilities, manufacturing sectors might be forced to scale down their production, ultimately resulting in decline in supplies and overall trade activities.

"We have been expanding for the last several years by availing low-cost foreign currency loans. Currently, we are working on to set up three new factories, but we've to delay the plan because of the cost hike," said MA Jabbar of DBL Group.

BSRM Group, which is the largest steelmaker in the country, is also concerned about the tax imposition on foreign loan's interest, which is feared to hike their cost of machinery and raw materials.

"Local entrepreneurs will be discouraged to seek foreign loans due to high cost and foreign currency shortage will be more acute," said Tapan Sengupta, deputy managing director of BSRM Group, in a letter sent to the president of the Chittagong Chamber of Commerce and Industry on 10 July.

A senior official from one of the country's prominent business groups pointed out that the imposition of this tax is likely to lead to rising production costs with a cascading effect on already high inflation and export revenues.

"Also, there is a possibility that the items currently manufactured to meet domestic demands might necessitate imports from foreign sources. This shift could result in a surge in import expenditures," said the official. 

Furthermore, a reduction in the import of crucial capital machinery could contribute to a decline in private investments, ultimately leading to a decrease in the creation of new employment opportunities, he said.

The official said that a year and a half ago, the price of the dollar was Tk85, now it stands at around Tk109.50. Due to the currency depreciation, the repayment burden has already increased by about 30%. Now with the imposition of new taxes it has become difficult for us to repay the loans taken earlier, he noted.
 
Banks' concerns

Meanwhile, a private bank has written to the central bank stating that the tax on interest of foreign loans will increase the cost of banks.

The letter explains how Interest costs of banks will increase due to taxation of interest on short-term loans they borrow from foreign banks through offshore banking units, one of the sources of foreign currency liquidity. The tax will also impact the banks' offshore banking unit transactions for short term import bill discount, export bill discount, making mid- and long-term financing and supporting financing export processing zone, economic zones and hi-tech parks.

The letter also said that the buyer's credit facility for industrial customers in international trade finance for onshore will decrease due to tax imposition. Besides, letters of credit (LCs) confirmation charge and trade finance cost will increase.

This tax will inhibit banks' ability to secure foreign currency from overseas sources, exacerbate the foreign currency challenges in Bangladesh, increase the cost of funds for local banks, and ultimately create challenges to business and economy to a great extent. This hampers the banks' capacity to negotiate favourable loan terms with foreign banks and institutions.