The country’s banking sector is facing a decline in short-term loans, resulting in a significant impact on the financial account. In the July-September period of the current fiscal year, the financial account fell into a deficit of nearly $4 billion. This decline in short-term loans has accelerated the depletion of foreign exchange reserves.
Data from the central bank reveals that the country repaid $24 billion in short-term foreign loans in the first eight months of this year, exceeding the amount borrowed by approximately $5 billion. Consequently, the total private sector external debt has decreased from $16 billion in December of last year to $12.42 billion in September.
Short-term loans, including buyer’s credit, deferred payment, back-to-back foreign letters of credit, and short-term trade loans, are crucial components of the financial account. However, banks have been repaying more than they borrow, as foreign lenders are hesitant to provide fresh loans due to the rapid erosion of reserves and diminishing repayment capacity.
The ratio of short-term external debt to foreign exchange reserves surged to 65% in June, indicating that the country has to allocate $65 for external payments for every $100 in reserves. Just two years ago, this ratio was at 30%. According to international economic guidelines, a country’s reserves should match its short-term external debt. Currently, Bangladesh’s foreign exchange reserves stand at $19.52 billion as of November 23.
The declining reserves coverage of short-term external debt has significantly impacted the country’s creditworthiness. It has also led to a negative growth in short-term loans, which are crucial for maintaining a healthy financial account and ensuring a steady inflow of foreign currency.
Dr. Ahsan H Mansur, the Executive Director of the Policy Research Institute (PRI), highlights that this vulnerability in creditworthiness exposes the country to serious risks. He explains that short-term loans from foreign private lenders contribute to improving dollar liquidity and maintaining a surplus in the financial account. Therefore, it is essential to have a surplus financial account to rebuild reserves. In the previous year, Bangladesh’s reserve crossed $45 billion primarily due to a significant surplus in the financial account.
To address the declining inflow of short-term loans, Ahsan H Mansur suggests that Bangladesh Bank should increase local lending rates to make funding from local sources costlier. This step would encourage businesses and banks to consider borrowing foreign loans, given that borrowing in the local currency is currently cheaper. He emphasizes the necessity of increasing dollar liquidity through short-term loans to improve the country’s capacity for making other payments.
In terms of external debt coverage, Bangladesh’s foreign exchange reserves to total external debt ratio is 24.8% in FY23. This means that the country has $24 against every $100 in loans. Comparatively, India’s reserves cover over 92% of its external debt. Bangladesh’s total external debt as of June was $98.94 billion, while the gross foreign exchange reserve stood at $24.75 billion. With the reserves depleting below $20 billion, the coverage ratio would be lower at 19.8%.
Zahid Hussain, a former lead economist at the World Bank’s Dhaka office, emphasizes the significance of reserve coverage to external debt ratio for short-term loans. He explains that although this indicator is not considered for long-term loans, as multilateral donors provide funds during times of crisis, it is vital for short-term loans since the declining reserve coverage erodes foreign financers’ confidence.
Bangladesh is currently in need of dollar liquidity, and an increase in short-term loans can contribute to improving dollar availability. However, the diminishing reserves have led foreign financers to hesitate in providing loans. Hussain suggests the removal of barriers to remittance through legal channels and an increase in exports to enhance dollar supply. Rebuilding confidence among foreign financers who lend to the private sector is also essential.
While Bangladesh still maintains a good debt-GDP ratio compared to other countries, the declining reserves coverage and shortage of short-term loans pose significant challenges to the country’s financial stability. It is crucial for Bangladesh to address these issues promptly to ensure a robust financial account and sufficient foreign currency inflow.
