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Market signals for higher interest rates!


Market signals for higher interest rates!

The government's move to keep both the interest rates on lending and deposit in banks at single digit level appears misleading. For more than a year, country's policymakers have been pressing to fix interest rate on lending at 9.0 per cent and on deposit at 6.0 per cent.  The idea was actually floated by private commercial banks through its platform Bangladesh Association of Banks (BAB). Both the finance ministry and Bangladesh Bank endorsed the rate fixation. Economists, analysts and experts have, however, strongly opposed the move. They have been arguing that dictating interest rate goes against the normal functions of financial market. They have also cautioned that imposition of rates may unstable the overall financial market.

Financial market in Bangladesh has already gone through a series of reforms. Due to these reforms, the market as well as the monetary management is now largely responsive to demand and supply. It means, different factors are there to move the interest rates where managing the demand with supply is the key issue. Defying these factors and demand-supply mechanism may seriously disrupt the financial mechanism in the country.

No doubt, lower lending rate is instrumental to reducing the cost of doing business and enhancing investment. It was in 2003 and a few consecutive years when Bangladesh Bank vigorously pushed the commercial banks to reduce interest rates. The central bank, however, didn't intervene directly or fixed the rates. Instead, it gradually reduced the policy rates, issued different policy instructions to cut over-expenditure of banks, encouraged banks to adopt tech-based solutions. In this process, the country's financial market gradually got accustomed with more market-driven approach on setting the interest rates. The approach later consolidated and the central bank started to operate monetary management more independently and flexibly. Despite a number of limitations on monetary operations, interest rates become the matter of market force in general.

Instead of overcoming the current limitations to make the monetary operations including determining the interest rates more market-oriented, the current move to fix the deposit and lending rates at 6.0 and 9.0 per cent respectively appears to be a reversal of the market-driven approach. It is also likely to promote distortion and inefficiency in the banking sector.

Policymakers need to look into the current trend of money market as well as the signals in the market.  Yield rates of the government's fixed income tradable securities provide a strong signal on interest rate in the market.

Central bank statistics showed that yield rates of the short-term government securities increased sharply last year while there was a moderate increase in long-term government securities. Treasury bills with different maturities are considered short-term fixed income securities while treasury-bonds with different maturities are known as medium-and-long-term securities. Through these securities, the government borrows from the money market. These securities are tradable at secondary money market, though partially.

According to Bangladesh Bank data, average yield-rate of 91-day treasury bill increased to 5.59 per cent in the past year which was 2.13 per cent in 2018. Thus, average yield rate of the short-term government securities turned more than double within a year. Table-1 shows the trend of annual average yield rates of different government securities. Two things are clear from the table: there is an increase in the yield rates of all types of treasury bills and treasury bonds; and the longer the maturities of the securities, the lower the pace of increase in the yield rates. For instance, yield rate of 2-year treasury bond increased by 58.42 percentage points while the rate of 10-year treasury bond increased by 19.58 percentage points during the period under review.

The upward trend in yield rates of different government securities signals that market is now in favour of rate hike. To put it in another way -- there is tightness in banks for lendable funds and so supply against demand for credit by the government is little lower resulting in the rise in interest or yield rates of the securities.

Again, higher pace of increase in the yield rates of treasury bills or short-term securities means the government is in need of immediate fund to finance deficits. Lower pace of increase in long-term treasury bonds, however, indicates that there is less demand for long-term government borrowing. Nevertheless, commercial banks want to make long-term investment in a safer tool -- government bond, for better return when they are under pressure to cut both the deposit and lending rates.

Average yield rates of half-yearly and annual treasury bills stood at 6.11 per cent and 6.45 per cent respectively last year.  If commercial banks charge more than 6.0 per cent on an average for totally risk-free lending, how is it possible for them to lend at 9.0 per cent for risky and complex business ventures? The monthly trend of yield rate of 364-day treasury bill may tell more.

Since June last, the average yield rate of 364-day treasury bill stood above 7.0 per cent and reached its highest level of 8.55 per cent in September. At the end of December last year, it came down to 7.98 per cent. This also indicates that market is not at all ready to accept a 9.0 per cent lending rate. Weighted average lending rate of scheduled banks stood at 9.63 per cent in November, according to Bangladesh Bank statistics. At the same time, average deposit rate came down to 5.71 per cent and below the monthly inflation rate of 6.05 per cent. Thus, there is an erosion of real income for the depositors for perking their money in banks.

Against this backdrop, it is evident that the market is craving for higher rate of interest. It doesn't mean that it has to be done forcibly.  Through the regular market mechanism, the rates will be increase to  optimal level and again come down when supply of fund will be adequate. 

 

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