Differential interest rate structure in Bangladesh financial market

Bangladesh has experienced a stable macroeconomic condition with higher Gross Domestic Product (GDP) growth rate, 6.5 per cent to 7.25 per cent, during the period 2011-2022 except the Coivd-19 affected year 2019-2020 (GDP growth rate was 3.45 per cent). A rapid monetisation of the economy, especially in the post-reform period, contributed to attaining such higher and steady growth trajectory. The monetisation of a vibrant economy requires a financial system that ensures efficient financial intermediation. While continuing such higher economic growth, it is necessary to ensure an efficient financial market where interest rates shall be determined through market mechanism in mobilising fund from surplus unit (savers) to deficit unit, i.e., in prospective productive business.

The core problem in attaining such efficient financial intermediation is the existing distortion in the financial prices in the financial market of Bangladesh due to differential interest rate structure, especially higher returns on different saving schemes of the government compared to the deposit interest rates offered by the banking sector in Bangladesh. Moreover, following the recent government decision, banks brought down the deposit interest rate within 6.0 per cent from February 1, 2020, whereas the interest rates for government saving schemes (e.g., NSCs and postal saving schemes) remain between 9.00 to 12.50 per cent. This differential interest rate structure causes distortion in the financial market as the interest rates are not determined through market mechanism. Therefore, it would be hard for different financial intermediaries to attract the required fund for investment at a lower lending rate, which eventually would have adverse effect on the growth of the economy.

The effects of distortions in the financial prices are manifold. One of the major consequences of distortion is financial repression due to government intervention in fixing bank deposit interest rate at a lower rate compared to other government savings schemes (i.e., national saving certificates and postal saving schemes). Ronald McKinnon (1973) and Edward Shaw (1973), the proponents of financial reform, termed distortions of financial prices including interest rate control as 'financial repression' which is a common phenomenon in most developing economies. The theory of financial liberalisation also contends that savings will be allocated and invested more efficiently in a liberalised environment with financial intermediation, than when savings are invested directly in the sector in which it takes place, without financial intermediation. However, banks may be reluctant to go for private sector credit disbursement because of lower spread due to the execution of the government decision on putting ceiling on both deposit and lending interest rates (6-9 per cent). As a result, fund has been diverted to high yield government saving scheme and economic growth would be more dependent on public sector investment instead of private sector investment because there would be fewer funds for private sector credit.

CAUSES OF FINANCIAL PRICE DISTORTIONS: The root cause of distortion in the financial prices in the financial market is the existing differential interest rate structures, especially higher interest rate structures of the NSCs and Postal saving schemes compared to other financial intermediaries. The situation has become worse due to the recent government initiative to fix the deposit interest rate at a maximum of six per cent in banks while the interest rates for NSCs and postal savings schemes are in between 9.00-12.50 per cent.

GOVERNMENT INTERVENTION IN FIXING INTEREST RATE STRUCTURE IN BANKS: The government has intervened in fixing the deposit and lending interest rates in banks capping a single digit band 6-9 per cent.  This intervention in a liberalised financial market, where interest rates are allowed to be determined through market mechanism, has created distortions in the financial market in Bangladesh. The deposit growth in banks has been experienced a steep decline since 2020 as a direct impact of fixing the saving interest rate at six per cent. The banks' deposit growth dropped  to 1.07 per cent in November 2022 whereas the deposit growth was 14.37 per cent in June 2021. Therefore, it would be hard for the bank to manage loanable funds if such declining deposit growth persists.

GOVERNMENT DEPENDENCE OF BORROWING: The central bank of Bangladesh (Bangladesh Bank) has revised the public sector credit growth target to 37.7 per cent from 26.6 per cent in the monetary programme for July-December 2022 indicating a large amount of public borrowing in the fiscal year 2022-23. The government already borrowed Tk 3224.93 billion from banking sources during July-December 2022, a significant increase against TK 1912.87 billion during July-December 2021. The increased public debt has two implications: one is higher interest rates in government T-bills and T-bonds to get more bank finance, and the other source of government borrowing is directly from public through high interest bearing NSCs and postal savings schemes. In fact, yields on Treasury bills and bonds have increased by 3 to 5 percentage points in the past one year. The interest rates for government T-bills and T-bonds now range between 8.00 to 9.00 per cent depending on the tenor of the instrument.

HIGHER INTEREST-BEARING NSCS: Currently, four different National Saving Certificates are available where people invest their savings. These are: (1) 5-year Family Savings Certificate; (2) 5-year Pensioner Savings Certificate; (3) 5-year Bangladesh Savings Certificate; and (4) 3-year Quarterly profit-based Savings Certificate. The interest rates of these saving instruments ranges from 9.00 per cent to 11.76 per cent. Due to attractive higher interest rates offered, the sale of NSCs has increased over the years.  Available data show that the outstanding amount of NSCs sales increased 75.84 per cent during the period FY 2017-FY2022. The amount was Tk 2039.3 billion in September 2017 which increased to Tk 3640.1 billion in FY 2021-22.

HIGHER INTEREST-BEARING POSTAL SAVING SCHEMES: Saving accounts in post offices are getting soaring deposits due to the  high interest rates. There are two types of postal savings schemes:  Ordinary account and 3-year Fixed Deposit account where the interest rates are 7.5 per cent and 11.28 per cent respectively. Available data show that deposits in ordinary/general accounts significantly increased to Tk 47.63 billion in FY2021-22 from Tk 13.25 billion in FY2014-15. Similarly, savers deposited Tk 274.23 billion in FY2021-22 in fixed deposit accounts in post offices, whereas total fixed account deposit received was Tk 52.10 billion in FY2014-15

EFFECTS OF FINANCIAL PRICE DISTORTIONS: The effects of distortions in the financial prices, created due to the differential interest rate structure in the financial market, are manifold. First, financial repression due to lower deposit interest rates in banks. Second, fund has diverted to high yield government saving schemes. Consequently, economic growth would be more dependent on public sector investment instead of private sector investment since there are fewer funds available for private sector credit.

REPRESSION IN THE FINANCIAL SECTOR: LOWER DEPOSIT GROWTH IN BANKING: The government has intervened in fixing deposit interest rates in banks at a lower level compared to other government saving schemes. As a result, the growth in bank deposit has declined.

 The other reason for such declining trend in deposit growth in the banking sector is the negative return of deposit. The return from bank deposit goes negative while such lower deposit interest rate is adjusted to inflation. Because lower the real interest rate on deposit, lower will be the drive from the people to deposit.

FUND DIVERTED TO NATIONAL SAVING SCHEMES: Due to higher return in the government savings instruments -- both National Saving Certificates (NSCs) and postal saving schemes -- people are more interested to save in NSCs and post offices. A survey conducted by Bangladesh Bank (2019) finds that the net sale of NSCs was only Tk 47.9 billion in Fiscal Year 2011-12, but gradually people moved to buying NSCs over the years due to higher returns and therefore, net sales of NSCs reached to Tk 4653.0 billion in Fiscal Year 2017-18. Similarly, postal savings schemes have become popular to the savers due to higher returns compared to the banking sector.

INCREASED DIRECT BORROWING OF THE GOVERNMENT: Due to increased borrowing of the government resulting from the large volume of postal savings and sales of NSCs, public debt has  increased to a large extent. High public debt leads to higher long-term interest rates. The growth in public sector borrowing has been revised upwards from 26.6 per cent to 37.7 per cent in the revised monetary programme. This may not contribute in the growth process of the country if it is used for current expenditure of the government. However, public sector investment also has increased over the years. The public sector credit growth was 6.72 per cent in FY 2013-14 which increased to 27.67 per cent in FY2021-22.

Besides, government borrowings from the banking system increased mainly due to increased dependency on banks for deficit financing in the face of lower-than-targeted growth of governments revenue. while private sector credit growth was only 12.8 per cent  as on December 2022 against the target of 14.1 per cent.

The surge in public borrowing from banks has significantly increased the risk of further reducing the availability of credit to the private sector through two channels. One is through reducing the availability of liquidity for lending to the private sector. Bank liquidity was already constrained by weak deposit growth and increased non-performing loans (NPLs). The other channel is interest rates. Yields on Treasury bills and bonds have increased and ranges between 8.00 to 9.00 per cent depending on the tenor of the instrument. However, the deceleration in private credit was caused partly by the slowdown of import demand induced by the weak export demand on the back of ongoing trade tension and global economic slackness, and partly by the wait-and-see attitude of investors and traders regarding fresh credit demand ahead of the execution of government's highest lending interest rate ceiling of 9 percent from 1st of April 2020 (BRPD Circular 03, Bangladesh Bank, 24 February 2020).

STAGNANT PRIVATE SECTOR INVESTMENT GROWTH: To continue the economic growth trend of 8 per cent and above, investment as a percentage of GDP should be increased. Data show investment as a percentage of GDP was 24 per cent in 2000 which increased to 31.68 per cent in FY 2022. Private sector investment remained stagnant at 7.62 per cent of GDP in FY 2021-22. Private sector credit growth was 13.9 per cent in October 2022. Such lower level of credit flow to the private sector due to fewer fund availability and other reasons is the major hindrance to higher economic growth.

CHALLENGE IN ATTAINING HIGHER ECONOMIC GROWTH TARGET: Bangladesh has been experiencing a steady growth trend, six to eight per cent in the past one decade or so. The interesting phenomenon of such higher growth trajectory is that public sector contributes more to the growth process.  Since aid flow has  declined over the years, due to many reasons, the government is now heavily dependent on borrowing from domestic sources, both direct and indirect, to finance public sector investment. But private sector investment remained stagnant during the past one decade or so. To attain the SDGs and become a middle-income country by 2021, an efficient financial sector needs to be developed so that financial resources are allocated properly ensuring adequate credit flow to the private sector so that investment GDP ratio can be accelerated to 40 per cent of the GDP.

Dr. M. Kabir Hassan is Professor of Finance at the University of New

Orleans, New Orleans, USA. [email protected]

This article is based on A Critical Analysis of the Differential Interest Rate Structure in Bangladesh Financial Market, Working Paper 2023 by Kabir Hassan and Iftekhar Robin