Deferred LCs hit record $1b in July as banks lack dollar
Deferred payment fuels inflation and increases reserve risk
As the dollar crisis continues, banks are opening more and more LCs on terms of deferred payments, an arrangement where they pledge to pay the exporters much later after the goods arrive. The importers who are now forced to opt for deferred payments for the dollar crisis are counting hefty extra costs for the facility, and yet this is the best option available to them if they have to keep their business running.
Right this year in July, banks have opened a record $1 billion LCs on deferred payments.
Other than the importers bearing extra costs, this import arrangement has other negative consequences. First, this further fuels inflation. Secondly, the accumulated payment obligation will suddenly create a shock for the forex reserves when the time comes to repay. In other words, today's problem is only being shifted to tomorrow unless something dramatic happens to jack up the inflow of dollars.
Bankers said importers are obliged to reimburse the loan, complete with an interest rate of approximately 9%, and subject to an additional tax of 20% on the interest amount pertaining to these deferred payments.
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Deferred payments come at a cost
"Aside from government LCs for import of petroleum products and fertiliser, almost 80% of the remaining LCs are being opened with deferred payments," said the head of a leading private commercial bank.
Also, Bangladesh Bank data shows deferred payment against LCs, including buyers' credit reached a record high of nearly $1 billion in July as banks adopted a temporary mechanism to shift current liabilities in future amid a severe dollar crisis.
A deferred payment is one that is delayed, either completely or in part, in order to give the person or business making the payment more time to meet their financial obligations.
Although payment delay momentarily relieves pressure on foreign exchange reserves, it comes at the cost of inflation and increases reserve risk if the macroeconomic situation does not improve, according to sector insiders.
It is because, when payment is deferred, suppliers charge interest on importers – SOFR (5.3%) plus 3.5% margin – which is ultimately passed on to consumers, fueling inflation at a time when food inflation reached 12.54%, the highest in nearly 13 years.
Meanwhile, the country has already gone through a bitter experience of deferred payments piling up during the pandemic period and banks are still under pressure from previous pending payments. Hence, the foreign exchange reserve kept sliding even after a drastic fall in imports as banks were meeting previous payment obligations.
Deferred payments which usually hover between $400 million and $500 million jumped to $955 million in 2021 due to a pause in payment obligations during the year 2020 when Covid-19 first hit the country.
Deferred payment had boosted reserve to $48b
Deferred payment helped the country make a record in building foreign exchange reserve of $48 billion in August 2021. However, when payment started in 2022, it eroded the reserve, landing it at $23 billion in August this year, according to Bangladesh Bank data.
The Bangladesh Bank could not stop the slide of reserve even after a 15.76% year-on-year negative growth in imports in FY23 only because of previous payment obligations.
The private sector external debt declined by $3 billion in the first seven months of 2023 to $13.38 billion in July as importers are not taking foreign loans amid import restrictions and high-interest rates.
When contacted, Syed Mahbubur Rahman, managing director of Mutual Trust Bank, told The Business Standard that most banks are opening import LCs at deferred payment for three to four months instead of sight LC. This is because banks can cover only existing payment obligations with their dollar balance.
Sight LC refers to a credit arrangement where importers have to make an immediate payment after getting the delivery of goods.
Deferred payments to fuel inflation
Rahman said deferred LCs give importers time to make payment after selling their goods which also ease pressure on the reserve. However, importers will have to pay additional interest for deferred payment which will increase the cost of goods impacting inflation.
He said though the dollar balance in nostro accounts – refers to a bank account held in another country by a domestic bank – improved, the central bank is still selling $1 billion every month.
It will be difficult to rebuild the reserve in line with International Monetary Fund (IMF) conditions if the dollar inflow does not improve, Mahbubur Rahman said.
The senior bank official also said remittance inflow remained stuck. It needs to improve to ease the dollar crisis.
It is good that export orders are increasing but the impact will be in the next year. But it is not yet enough to support our foreign exchange balance. So the chances of improving the dollar crisis in the next six months are slim, Mahbubur Rahman added.
A senior executive of the Bangladesh Bank said, "Deferred payment is an immediate caution for reserve. There is a possibility of reducing the global interest rate in the next six months which will help importers to reduce cost by delaying payment."
However, if the dollar crisis does not improve, the country will face a similar situation as it faced during the second half of the pandemic when the reserve started depleting fast after deferred payment began, he said.
"Sri Lanka deferred their payments with Bangladesh due to their dollar crisis. But they are now able to make payments as the situation has improved. But they had to pay an additional charge for the delay in payment. So, importers will have to bear additional charges for deferred payments which will increase inflation," the central bank official added.
Inflation which remained upward mainly because of high import costs increased by 23 basis points to 9.92% in August while food inflation surged to 12.54%, according to the Bangladesh Bureau of Statistics (BBS).
