The Bangladesh Bank has agreed to use foreign exchange reserves as a source of loan, but on a limited scale only for foreign payments for government bodies instead of creating a separate fund.
The board of the central bank made the policy decision to finance from forex reserve primarily in two sectors – power and port development projects.
Sharing the central bank's plan, a board member told The Business Standard that the loan will be given from the reserve when the government makes foreign payments.
Giving an example, he said that such practice already exists in case of giving loans to national flag carrier Biman Bangladesh Airlines.
Biman was given foreign loans from the reserve through state-owned Sonali Bank multiple times.
The loan was given when Biman made foreign payments from Washington for aircraft purchase from Boeing. In that case, the Bangladesh Bank provided loans to Sonali Bank's Nostro account.
A Nostro account refers to an account that a bank holds in a foreign currency in another bank.
The Bangladesh Bank provided funds at 2-2.5% to Sonali Bank, and the bank charged 0.5-1% commission while giving Biman loans at around 3%.
As a result, Biman got the loan at a cheaper rate instead of receiving financing from a foreign bank at a higher rate.
On the other hand, the Bangladesh Bank received a comparatively high return by giving loans to Biman from foreign exchange reserve when the annual return from foreign exchange reserve was less than 2% at that time.
The Bangladesh Bank will follow this model in case of using foreign exchange reserves for other government projects, said the board member requesting anonymity.
He said currently, annual return from the foreign exchange reserve had come down to 1% due to a decline in interest rate worldwide. In this case, giving loans to government projects will be a better option for the central bank.
The loan will be given for very specific projects like port development and the power sector, he said.
Though the government has been pursuing to create a separate fund from foreign exchange reserves, the board of the Bangladesh Bank refused to do so, he added.
He said the board agreed to use the foreign exchange reserve as the current level of reserve is very high.
The Bangladesh Bank's move came after Prime Minister Sheikh Hasina raised the topic of taking loans from the forex reserves at a meeting of the Executive Committee of the National Economic Council (Ecnec) on July 6.
Following that meeting, the finance ministry in a letter referred to the discussion at the Ecnec meeting and urged the Bangladesh Bank governor to take necessary and effective measures in this regard.
Officials at the finance ministry said loan support from foreign sources, such as the World Bank, the Asian Development Bank, and China, for large development projects in the public sector might shrink in the future because of the current Covid-19 situation. Therefore, initiatives must be taken to implement projects with the government's own fund.
In this situation, the government will meet the demand for foreign currencies by taking loans from the forex reserves, they added.
Backed by strong remittance inflow and lower import expenditure, the country's foreign exchange reserve exceeded the $38 billion mark for the first time on August 18. The current foreign exchange reserve is enough to meet the import demand for more than seven months while the international standard is three months.
Although the foreign exchange market is stable with a surplus balance of payment, the Bangladesh Bank anticipates further deterioration of the current account deficit in the near future due to negative export earnings and job losses among Bangladeshi migrant workers.
In the latest monetary policy for the current fiscal year, the deficit in the current account is anticipated to slightly deteriorate with moderate receipts in financial accounts compared to the previous year.
The balance of payment witnessed a surplus of $3,655 million in FY20, which was the result of a decline in the current account deficit on the back of robust remittance inflows along with higher inflows of foreign direct investment (FDI) and somewhat healthy inflows of medium and long-term loans.
However, the deficit in trade balance widened to $17,861 million during this period amid a decline in exports and imports by 16.9% and 8.6% respectively, owing mainly to sluggish domestic and international demand during the first half of FY20, which was further aggravated by the worldwide outbreak of Covid-19, according to the monetary policy statement.
Examining the risk factors in using reserves to finance public investments, Zahid Hussain, former chief economist of World Bank's Dhaka office, wrote an opinion piece on 8 June, 2020 in The Business Standard. In it, Hussain says, economists commonly use, in normal times, two rules of thumb as starting points in answering this question.
"Reserves should cover three months of projected imports. There is no scientific basis for this ratio. It is a commonly accepted threshold blessed by the International Monetary Fund. It focuses solely on the flow of goods and services.
"In a country like Bangladesh, this is an important shortcoming. Importing more goods and services than we export, it is necessary to attract more capital than we launder out of the country," he explained.
Zahid went on, "A second widely used indicator is the ratio of reserves to broad money. This is the amount of printed currency outside the banking system as well as checking and time deposits. Banks never have all the deposits in their vaults because only a fraction of the depositors demand access to their funds on any given day."
"The same is true for reserves. Only a fraction of the holders of the local currency would want to convert it into foreign currency on any given day. The benchmark considered adequate in this instance is that reserves should be around 20% of broad money to cover against money supply being converted into foreign currency in the short-to medium-term for purchasing goods and services or 'investments' abroad," he said.
The economist went on to say these two ratios are useful but not sacrosanct. "They ignore factors that need to be considered when determining the benchmark. The challenge is to be sure that the thresholds are adequate and give the captains of macroeconomic management enough time to prepare. Following conventional rules can result in failure to signal distress before it is too late."
Zahid said if reserves can be used to finance public investment projects, it is critical to assess rigorously and independently what foreign exchange reserve level is the minimum needed to comfortably meet the foreign exchange obligations.
"The failings of governance in the government expenditure management framework is also a key consideration. There is not much comfort in the existing macroeconomic framework to warrant voluntary parting with reserves as an alternative to seeking external financing," he added.