Cenbank raises rates to tackle inflation

Infographic: TBS

Interest rates on loans are expected to climb to 11%, up from the previous 10.70%, as a result of the government's borrowing through treasury bills and bonds at higher interest rates to curb the mounting inflation.

According to the Bangladesh Bank, the new lending rate is likely to be effective from 1 November.

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In July, the Bangladesh Bank introduced the Six Months Moving Average Rate of Treasury Bill (SMART) as the benchmark for determining interest rates. This was in line with the conditions set by the International Monetary Fund (IMF) to allow market forces to dictate rates, rather than adhering to the earlier cap of 9%. Lenders can now add up to a 3.5% margin to set interest rates on loans.

In July, the SMART was at 7.10%, and by September, it had risen to 7.20%. In October, an additional 0.20 basis points increase pushed it to 7.40%. This escalation in rates is attributed to the government's borrowing through treasury bills and bonds at higher rates.

Data from the Bangladesh Bank reveals that the interest rate for 91-day treasury bills climbed from 7.21% on 12 September to 9.24% on 15 October, while the rate for 182-day treasury bills surged from 7.39% to 9.47%. The government has borrowed Tk29,048 crore through these treasury bills from 1 July to 18 October, and the entire amount has been utilised to repay loans from the central bank.

A senior Bangladesh Bank official said, "The central bank is taking steps to control inflation by raising interest rates. The government is also borrowing at higher rates to absorb funds from the market."

As part of this strategy, the repo rate was increased by 75 basis points to 7.25% at the beginning of October, marking the record rate hike in a decade.

However, despite the increase in interest rates, inflation has not receded significantly. In September, inflation saw a slight decrease from 9.92% in August to 9.63%.

Food inflation reached 12.37% in September while general inflation has remained consistently above 9% since last March, substantially impacting the cost of living, particularly for low-income groups. The Bangladesh Bank has now set a target to bring inflation down to 8% by December.

However, this policy shift has secondary consequences. The banking sector is facing a liquidity crisis, and the private sector is likely to feel the impact as loans become costlier. This may lead businesses to delay their expansion plans or new investments, potentially affecting job creation, according to experts in the banking and economics sectors.

Zahid Hossain, former lead economist of the World Bank's Dhaka office, said that he suggested increasing interest rates to control inflation during a meeting with the central bank governor last week.

He said gradually increasing the 3.5% corridor along with the smart rate, meaning that if it is increased by Tk1 in each monetary policy meeting, it will be more than Tk6 by the end of 2026, but this may change depending on market conditions.

Call money rates increasing

Banks transact in the interbank call money market to meet temporary liquidity needs. The overnight weighted average rate of the continuous call money market has been rising since early October.

On 2 October, banks borrowed Tk5,129 crore from this market at a rate of 6.56%. The rate rose to 7.34% on 10 October, with a turnover of Tk4,991 crore. On 15 October, the overnight weighted average rate in the call money market rose to 7.48%. Lastly, on 30 October, this rate rose to 7.76%.

Bankers said the call money market rate is also increasing as the central bank's policy rate increases. This is because banks that take credit facilities from the central bank through repo must operate at a higher rate in the call money market. Many banks are therefore forced to lend at higher rates.

On 30 October, a bank borrowed Tk5 crore at 10.00% on 14 days' notice in the call money market, and another bank borrowed Tk15 crore at 9.50% interest for a period of three days. However, the central bank has directed that the maximum rate in the call money market be 9.25%.

Banks' excess liquidity shrinking

Excess liquidity in banks decreased by about Tk6,000 crore in August compared to July due to higher government treasury bill and bond rates. At the end of August, excess liquidity in the banking sector stood at Tk1.74 lakh crore, down from Tk1.80 lakh crore at the end of July.

Excess liquidity is calculated after fixing the statutory liquidity ratio (SLR) and cash reserve ratio (CRR). Banks are required to deposit 4% of total deposits in cash and 13% in non-cash form with the Bangladesh Bank. Excess liquidity is invested in government bonds, which allows the government to borrow from the banking system.

Banks' excess cash liquidity, which is the amount of cash they hold above the required cash reserve ratio (CRR), stood at minus (-) Tk2,165 crore as of 15 October, down from Tk5,050 crore on 2 October and more than Tk8,000 crore in June. This decrease is due to the central bank selling an average of $70 million per day from its reserves, which has drawn Tk774 crore out of the market every day.

A bank official said it is difficult to control inflation when people have more money outside of banks. Many banks are offering deposit rates above 10%, but this is not enough to attract more deposits. According to August data, there is still Tk2.58 lakh crore in the hands of people outside of banks. This is down from the highest amount of Tk2.92 lakh crore in June.

Due to the liquidity crisis, banks are increasing the amount they are borrowing from the central bank through repo and reverse repo on short-term notice. In August, banks borrowed an average of Tk6,000 crore from the central bank every day. This increased to an average of Tk8,000 crore in September, and Tk15,000 crore in October. Banks typically take these loans for a term of 1-7 days, the official said.

Decline in private sector credit flow

Private sector investment is declining due to rising interest rates on bank loans and uncertainty surrounding the upcoming national elections.

In August, private sector credit growth in Bangladesh fell to 9.75%, the lowest in 22 months. This is as businesses and individuals reduce borrowing amid economic headwinds and uncertainty. Bangladesh Bank data shows that the last time private sector credit growth dipped below this figure was in October 2021, when it registered a growth of 9.44%.

Bankers say banks are investing in treasury bills and bonds because of higher rates, as private sector investment is low. Public sector investment offers security and timely returns, while lending at the customer level faces various problems with full recovery. As a result, banks are reducing loan flow.