Money is no problem?

The central bank is a key institution in the modern economy. Its function is to maintain stability in the macroeconomy and the financial system. In the advanced capitalist world, macroeconomic stability has come to mean maintaining price stability while growing the economy as close to its potential pace as possible. In addition to these, for a developing economy, macroeconomic stability could also mean exchange rate stability or maintaining solvency of the government. Financial system stability means maintaining a functioning banking system, keeping the credit flowing, and acting as the lender of the last resort.

During the COVID-19 pandemic, central banks around the world have had to balance all these tasks, and the Bangladesh Bank is no exception. In its latest Monetary Policy Statement, issued for 2020-21 financial year, the central banks states that —monetary policy stance monetary programs for FY21 are essentially expansionary and accommodative for all growth support needs without impairing attainment of the targeted inflation containment.

With inflation hovering around 5-6% (Chart 1) and expected to remain moderate into the foreseeable future, supporting economic growth has, quite rightly, been the central bank’s focus.

Has money been a problem for the economy during the pandemic?

Typically, to spur economic activities, central banks cut (or perform financial transactions that has the effect of cutting) interest rates. Lower interest rates mean lower financing costs faced by businesses, which make projects and ventures more worthwhile than would have been the case otherwise. This, in turn, creates jobs and boosts workers’ incomes, which then cascade through to the economy. In addition, lower interest rates help households spend on big ticket items such as houses, durables, or holidays, with flow on effects on the economy. 

The Bangladesh Bank has followed the textbook prescription, cutting the repo rate —the repurchase agreement rate, which is the rate at which the central bank lends to commercial banks —by 100 basis points between February and August 2020 to 5%, making funds cheaper for the banks. The reverse repo rate —the rate received by the commercial banks for parking their money at the central bank —was cut by 75 basis points to 4% in July, discouraging banks to keep money idle. As a result, average borrowing rates from commercial banks have fallen by over 200 basis points since March 2020 to be 7.56% in January 2021. After accounting for inflation, real interest rate for loans have been in the 2‑2½% range since the onset of the pandemic against 4% or so average before March 2020. Chart 2 shows how interest rates have tumbled in the past year.

Lower interest rates have translated into faster growth in money supply. Bangladesh Bank’s preferred measure of money supply is M2, which includes cash plus bank deposits that can be readily transferred into cash. In the year to January 2021, M2 grew by about 14% (Chart 3), in line with the central bank’s desired pace of growth as expressed in the Monetary Policy Statement.

So, money is no problem then?

Well, not quite. Chart 3 also shows that loans to the private sector grew by 8% in the year to January 2021, slowing by a percentage point over the last year, and contrary to the central bank’s desired acceleration — according to the Monetary Policy Statement, private sector credit was supposed be growing by 11.5% by now. That is, while money is cheap and available, the private sector is not borrowing it.

Of course, there are very good reasons why businesses are not keen to borrow in the current circumstances. The vaccines notwithstanding, the pandemic is still raging. Until the fog of uncertainty around the health emergency is lifted, no amount of money will, in and of itself, fundamentally help the economy.

In addition, going into the pandemic, banks were in rather rude health. As Chart 4 shows, over the past decade, non-performing loans — those loans where the borrower has failed to make interest or principal payments for an extended period of time, typically 90 days — have become a major problem for the nationalised commercial banks (Sonali, Janata, Pubali, and Agrani).

Of course, during the pandemic, a lot of previously performing loans have come under stress as businesses see their revenues fall sharply. Faced with cash flow problems, many businesses find it hard to repay loans. Responding to this, the Bangladesh Bank has put in a number of forgiveness, moratoria, rescheduling, and refinancing schemes.

The question is, how would these support measures evolve over time.

On the one hand, some of these schemes should continue until the economy improves. On the other hand, these measures cannot continue indefinitely. In a recent article, Forrest Cookson sketches out a set of near term support proposals. The proposals themselves are perfectly reasonable, but the conclusion that the Bangladesh Bank should ‘put aside other reforms’ until the crisis passes is not.

As the old adage goes, don’t waste a crisis. That the banking sector had been ailing is widely accepted. The solutions are technocratic and well within the capability of Bangladesh Bank staff. Tightening the criteria for rescheduling / restructuring of loans, strengthening the banks’ corporate governance, enforcing bankruptcy laws and such like, coupled with selected recapitalisation of banks, can de-risk the banking sector.

Absent reforms, moratoria and refinancing will risk encouraging bad behaviour from both borrowers and the banks. A credible path of reform of the banking sector in conjunction with near term moratoria and such like, on the other hand, will assure the private sector that it is worthwhile borrowing for new factories, commercial buildings, or expansion of existing facilities.

So, money indeed is a problem, but not for the private sector as such, but the banks.

Of course, banks lend not just to the private sector, but also the public sector. The Monetary Policy Statement envisaged private sector loans from banks to grow by over 35% in the year to December 2020. Chart 4 shows that the credit to the government and other public sector (public corporations and state owned enterprises) were growing by far slower pace than that. This might suggest that the government is not under fiscal pressure — that is, money isn’t a problem for the government, at least not yet. But to pass a verdict on that would require looking at the fiscal accounts, which is subject of another post. 

 

First published in Dhaka Tribune as an On the other hand column.