Private credit is growing in times of high inflation. What does it mean for the economy?
The Business Standard spoke with two eminent economists to understand the reasons behind the rise of private credit, what it means for an economy under inflationary pressure and how to curb this growth.
Private sector credit growth in Bangladesh rose further in July. Credit growth has in fact been rising for five months despite a number of measures from the central bank aimed at curbing import bills. Bangladesh's rate of inflation now stands at 7.48%, while food inflation is at 8.19%.
At the end of July, private sector credit stood at more than Tk13.52 lakh crore, in contrast to around Tk11.87 lakh crore at the same time last year.
Credit growth rose to 13.95% in the first month of the fiscal year, which was higher than the previous month's 13.66% and close to the monetary ceiling of 14.1% set for the current fiscal year.
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The average credit growth of last fiscal year stood at 10.67%, far below the monetary target of 14.8%.
The Business Standard spoke with two eminent economists to understand the reasons behind the rise of private credit, what it means for an economy under inflationary pressure and how to curb this growth.
'Borrowers are practically facing no borrowing costs whatsoever'
Ahsan H Mansur, Executive Director, Policy Research Institute of Bangladesh
Despite the recent macroeconomic pressure, the borrowing rates remain low in Bangladesh, which is encouraging borrowers to take out more credit and hence, leading to a higher private sector credit growth. Recently, Bangladesh Bank promised to adopt a cautionary and somewhat contractionary monetary policy and limit the private sector credit growth to 14.1% for FY 2022-23. Yet, we are yet to see any significant rise in the interest rate. Such a low borrowing rate is creating distortions in the market.
Given the recent hike in fuel prices, it is likely that the month-on-month inflation for August will reach 8-10%, which is higher than the borrowing rate that revolves around the 8% mark. That means borrowers are practically facing no borrowing costs whatsoever. It is unbelievable.
On the one hand, they are making more profits and reaping the benefits of inflationary pressure. On the other hand, they are receiving loans at a cost lower than the rate of inflation.
At the same time, the lower lending rate and a relatively constant interest rate spread led to stagnation of the deposit rates. So, consumers are not depositing their savings with the banks, which means they are holding onto their cash earnings and probably spending more. In an inflationary landscape, you want to restrict consumer spending to prevent prices from rising too far. But the lower interest rates are discouraging deposits. While consumers used to purchase national savings certificates previously instead of depositing with private banks, that effect has also been negligible this year. Overall, this high private sector credit growth coupled with a low deposit rate will increase consumer spending and may cause prices to rise further.
To tackle this, the central bank must raise the interest rates to increase the opportunity cost of holding onto money and encourage consumers to deposit with the banks. On the other hand, the advance rates should be raised beyond the 9% cap set by the central bank to limit credit growth in the private sector.
'Credit growth has happened due to exchange rate depreciation and increase in global commodity prices'
Zahid Hussain, former lead economist of the World Bank Dhaka office
I believe the 14% private sector credit growth can be attributed to trade credit growth. The main reason behind this trade growth credit is the fact that the same dollar now costs more to settle. The credit created against the foreign exchange sold by banks is at a much higher exchange rate. That is why credit growth is high.
Evaluating the monetary policy based on this is not logical because it has happened due to the exchange rate. If this happened due to a refinancing policy by Bangladesh Bank or rate of operation or due to liquidity injection, then you could say there is a relationship with policy.
The monetary policy should have been contractionary, but it is not. Even after the target was revised to 14.8% from 14.1%, it still remains higher than the 13.66% growth we achieved last year. Monetary policy targets two variables: 1) Reserve money, which is the operating target and 2) Broad money, the intermediate target.
Where the interest rate is capped, what is the instrument to achieve the monetary policy's intended target? The policy rate has been increased but there isn't much room to feel its impact since the borrowing rate is capped at 9%. If you take a look at the broad money rate target, it is higher than what we actually achieved last year.
The credit growth has happened due to exchange rate depreciation and the increase of commodity prices in the global market. So this credit growth can be credited to inflationary forces, but since it is mainly import-driven it is not necessarily increasing the supply of money in the local market. There is no reason for further impact on the domestic market as it is simply to make payments for imports we have already completed.
Looking at our import structure, I am sure most of these imports are industrial raw materials; there are definitely some essential consumption items like rice, edible oil, rice, etc. There is also fabric, yarn and accessories for our exporters. Whether it is consumption goods or capital machinery, it is increasing supply in the local market. Since supply is being augmented, this will help contain the inflation. This credit was not availed by consumers, it was availed by businessmen who availed it against imports. This credit will have to be repaid, so no extra money was injected.
However, some of the money could have gone to SMEs and large corporations. A complete breakdown of the credit would have been more helpful. If a large chunk of the loan went to consumers, then it would have worsened the inflation. If these loans expanded consumer or industrial credit, there could have been inflationary impact.
To curb credit demand, the interest rate could have been made flexible. But Bangladesh Bank has said they will not do so. Bangladesh Bank can influence aggregate demand through the instrument of interest rate, however it is capped. The only other thing they can do is to impose credit control which might do more harm than good.
