Rising interest rates: who pressed the panic button?

At the annual conference of Agrani Bank on February 17, Bangladesh Bank Governor Fazle Kabir stated that there was no liquidity crisis in the money market as reflected in the relatively low and stable call money rate, and yet the panic button was unnecessarily pressed pushing the interest rate up.

One would hardly disagree with the observation of the governor. But then, the question remains unanswered- who pressed the panic button and why? This write-up is an attempt at examining pertinent facts and stitching together a possible explanation.

MPS H2 FY18

BB announced its half-yearly Monetary Policy Statement (MPS) for January-June 2018 (H2 FY18) on January 29, 2018. The MPS indicated the following as key considerations underlying the policy pronouncement.

1. The sharp above-trend upturns in imports and in credit to private sector is a much-awaited robust pick up in investment and output activities, supported by progress in addressing infrastructural deficiencies, robust domestic demand, and a broad-based pickup in global output and trade growth.

2. Although it bodes well with growth going forward, it also poses near-term challenges of containing monetary growth-driven inflationary pressures and of protecting external sector balance of payments (BOP) sustainability. Accordingly, the MPS identified the twin tasks of keeping in check the inflationary risks and moderation of the transient external imbalances to sustainable trend as key priorities for monetary and macro-prudential policies for H2 FY18. 

3. The MPS proposed to perform these tasks not by blanket curve restricting access to credit for productive pursuits but by focusing on quality and sectoral composition of credit flows through intensive and intrusive supervision.

The premises laid out above seem fairly innocuous. But how well do the actual dispensations under the MPS match with these stipulations? Let us take a close look.

M2 GROWTH AND UNCHANGED POLICY RATES

The MPS left the repo and the reverse repo policy interest rates unchanged at 6.75 and 4.75 percent respectively. No changes were also made in the CRR and SLR policy parameters. It projected the growth of broad money (M2) at 13.3 percent against its actual growth of 10.7 percent during H1 FY18. The projected growth in M2 appears adequate to accommodate the targeted 7.4 percent real GDP growth and targeted 5.5 percent annual average inflation. So, it seems quite in line with the stipulation of not restricting access to credit across the board and, in a way, negates the criticism expressed from some quarters labelling the MPS as contractionary.

GROWTH OF RESERVE MONEY AND PRIVATE SECTOR CREDIT

The MPS rightly observed that growth of reserve money and its attendant inflationary impact is likely to remain moderate in H2 FY18 because of government's likely negative or small borrowing from the banking system and expected near zero growth in net foreign assets (NFA) due to high import payment outflows.   During H1 FY18, programme growth of reserve money was 12 percent with the growth of the three constituting elements, NFA, credit to the public sector, and credit to the private sector set at 5.4 percent, 12 percent and 16.3 percent respectively.

However, actual growth of the three monetary aggregates during H1 FY18 were, 0.5 percent, 9.3 percent and 18.1 percent respectively, with the overall reserve money growth being 13.3 percent. Accordingly, the MPS H2 FY18 lowered programme growth level of both NFA and credit to the public sector to 0.1 percent and 8.3 percent respectively but raised the programme growth level of credit to the private sector to 16.8 percent. So, here again, the programme growth of monetary aggregates indicated in the MPS does not seem to be at variance with the stipulations made.

The MPS has been criticised by some as being restrictive as it set the programme growth of credit to the private sector at 16.8 percent, lower than its actual growth of 18.1 percent during H1 FY18. However, it should be remembered that this is not a policy parameter in the sense that it does not impose any direct restriction on the actual growth of credit to the private sector. Rather, what the programme growth figure shows is the expected growth in the monetary aggregate consistent with the GDP growth and inflation target, taking other realities such as slow growth of NFA and credit to the public sector into considerations.

RATIONALISATION OF AD RATIO

As per the Asset Management Guideline of Bangladesh Bank issued on March 7, 2016, the board of directors could approve advances up to 85 percent of their deposits in the case of conventional banking and up to 90 percent of their deposits in the case of Islamic banking.

Unfortunately, although the news of several private sector banks crossing their AD ratio limits has been around for quite some time and Bangladesh Bank cautioned these errant banks, concrete punitive actions against the delinquent banks were not taken as a result of which the incidence of such violations became more widespread and acute. At the time of MPS announcement, nearly 20 private sector banks had made advances beyond permissible limits, some going even beyond 90 percent of their deposits putting at stake depositors' interest.

Before the announcement of the MPS, the capital market became tense apprehending strong action by Bangladesh Bank regarding AD ratio, and on January 28, the day before MPS announcement, DSEX declined by more than 1 percent. But after the announcement of the MPS, DSEX gained back 0.52 percent and rose from 6,144.7 to 6,176.4 points mark as the MPS did not have any declaration regarding AD ratio except saying that there will be new directive requiring banks to rationalise their advance/deposit (AD) ratio to curb their over-exuberance in lending. BB governor, in his presentation of the MPS, did not elaborate on what rationalisation of AD ratio exactly meant and assured that adequate time would be given to make necessary adjustment.

But on January 30, the day immediately after the announcement of the MPS, the central bank issued a circular bringing down the required AD ratio to 83.5 percent for conventional banking and to 89 percent for Islamic banking. Banks were given time up to June 30, 2018 to bring down AD ratio to this level at predetermined rates and were also asked to submit a concrete implementation plan to the Department of Off Site Supervision (DOS) by February 7.

As shown in the graph, the capital market experienced a free fall following this circular. On February 20, BB came up with a second circular extending the last date for rolling back AD ratio from June 30, 2018 to December 31, 2018, tacitly accepting the criticism that the circular of January 30 triggered the fall in the DSEX. But as is evident from the graph, the second circular failed to bring about any immediate improvement in the situation.

The money market had a similar story to tell. Banks that had advanced more than 90 percent of their deposits were facing difficulty in making new advances as their loanable fund stood depleted. So, these banks were already on the lookout for new deposits. It was also well anticipated that BB would get tough with the offenders and would require them to roll back their AD ratios within a given timeframe. Since advances made cannot be readily called back, the only way the AD ratio can be lowered is by raising the volume of deposit. So, all 20 banks that had exceeded the stipulated AD ratio went for desperate deposit hunt and deposit interest rate started rising since early January. But once the BB circular of January 30 further lowered the required AD ratio, the remaining private sector banks also felt the pressure for raising deposit and joined the bandwagon. No wonder, deposit interest rate continued creeping up steadily approaching double digit figure.

Many market analysts incorrectly diagnosed the problem as liquidity crisis and blamed the MPS for that. BB was quick to refute arguing, and rightly so, that measures undertaken by Bangladesh Bank had no adverse effect on money supply and, therefore, there was no scope for liquidity crunch. The truth is that the lowering of the AD ratio across the board suddenly created a surge in deposit requirements pushing interest rate up and shaking down confidence in the capital market.

I leave it to the readers to figure out whose fingerprint was there on the panic button.

 The writer is the chairman of Agrani Bank Ltd.