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Bangladesh Bank created fresh money of more than Tk50,000 crore in the July-December period for budget support, the highest in recent history
The interest rate on long-term government bonds shot up to 8.95% in the last auction called by the Bangladesh Bank on 28 December – at a time when the lending rate cap was 9%.
The question then arises why banks would lend at 9% to the private sector when they can instead get the same rate by investing in government bonds.
The climbing rate on government bonds is symptomatic of a liquidity crisis, a source at the central bank told The Business Standard.
Infographic: TBS
Infographic: TBS
Normally, the government borrows money from commercial banks, but in this situation, the Bangladesh Bank has started to print taka to supply money to the government.
The over Tk50,000 crore printed so far was the highest amount of freshly minted money in a single year in recent history.
In the latest development, the central bank provided Tk500 crore to the government through a 20-year bond auction on 28 December when the bidding rate was 8.95%.
Of the amount, Tk152.81 crore was collected from banks and the remaining Tk347.19 crore was supplied through fresh money printing.
They printed the amount to ensure that the interest-rates on bonds would not cross 9%. The rate was below 8% only last year.
A senior executive of the Bangladesh Bank, seeking anonymity, said the central bank has to maintain the bond rate below 9% as there is a lending rate cap.
As a result, the Bangladesh Bank is now issuing fresh money to meet the government's borrowing demand, he added.
If there was no lending rate cap, the government would have to instead borrow from the commercial banks at a higher rate, he explained.
In the face of the severe liquidity crisis, the central bank was forced to print fresh money amounting to Tk37,000 crore in the first five months of the current fiscal year.
The figure crossed Tk50,000 crore in December as the liquidity situation worsened, prompting the central bank to inject more money in the system, said a senior executive.
The government borrowed this amount from the Bangladesh Bank for budgetary expenditure.
The Bangladesh Bank did not issue fresh money in recent years, according to central bank officials.
The central bank opts for minting money only when the system becomes dry, they said, adding it is a very rare occurrence.
Injecting money to prop up weak banks
Zahid Hussain, the former lead economist at the World Bank's Dhaka office, said, "The question is, money injection for what? The Bangladesh Bank is injecting money in weak banks instead of recovering money from bad lending. For instance, Islami Bank gets liquidity support of Tk8,000 crore but the question is where this money is going."
Recently, a huge loan corruption has put the Islami Bank in a liquidity crisis, forcing it to borrow from the central bank to manage its required liquidity maintenance.
The bank's liquidity crisis also created panic among depositors, causing withdrawal pressure in the last several months, another reason for the overall worsening liquidity crisis.
Currency outside banks – money that is outside the banking system and in the pocket of consumers – peaked to 21% in November from 15% in October due to deposit withdrawal pressure. Deposit growth fell to below 8% in November from double digit in the previous year.
The central bank is pumping money instead of enforcing good governance. As a result, there is a chance of capital flight and financial instability for such monetary injections, Hussain said.
The journey to this point
Last year, the banking sector was awash with excess liquidity of above Tk2 lakh crore.
When banks have enough liquidity, they participate in auctions for government bonds.
The Bangladesh Bank calls the auction for banks to invest in government bonds and bills, through which money is collected for the budget.
Banks' investment in government bonds and bills are shown as excess liquidity.
But this year a serious dollar crisis dried up liquidity. Banks turned to the Bangladesh Bank for dollars and local currency ended up in the central bank's vault.
Amid this liquidity crisis, banks are bidding high interest rates which the central bank was unwilling to take to maintain balance with the lending rate cap.
As a result, excess liquidity in the banking sector came down to Tk1.50 lakh crore in November, central bank data shows.
In the current budget, the government is projected to borrow more than Tk1 lakh crore from the banking system.
In the first five months, however, the government did not borrow from the commercial banks.
Rather it paid them back Tk20,000 crore loaning it from the Bangladesh Bank intending to give borrowing space to the private sector.
But with raging inflation, the Bangladesh Bank's move to mint more money may only fuel inflation.
Infographic: TBS
Infographic: TBS
Pouring fuel in fire
When the Bangladesh Bank creates fresh money against its assets, it fuels inflation as the taka loses value.
In December last year, the government in its Economic Coordination Council on Fiscal, Currency and Exchange Rate meeting revised up its inflation target in the current budget to 7.5% from 5.6%.
Inflation has started to cool but at a slower pace, landing at 8.71% in December after peaking up to 9.5% in August last year.
Zahid Hussain, the former lead economist at the World Bank's Dhaka office, said the central bank is injecting fresh money at a time when there is no demand squeeze.
People have money in hand as reflected in the non-food inflation, which is close to double digits. Hotel occupancy rate in tourism spots is also high, he added.
Citing an example, he said the central banks in America and Europe injected money during the global recession but that did not put price pressure because there was demand shortage, while the economy had unused production capacity – known as economic slack.
"But Bangladesh is not in that situation because manufacturing companies are not running with unused production capacity as there is demand. In this situation, monetary injection may put pressure on inflation in the near future when the money enters the economy through government expenditure," he added.
Meanwhile, due to the liquidity crisis, the amount of loans from the central bank through the repo of the banks has increased massively.
According to the data of the central bank, the loan amount of the banks through repo in July this year was Tk13,619 crores. It rose to Tk16,206 crore in August.
The loan volume increased further to Tk29,650 crore in September.
Some Tk79,641 crore was taken in October and Tk61,803 crore in November.
A repurchase agreement, or "repo," is a short-term agreement to sell securities in order to buy them back at a slightly higher price. Repos and reverse repos are thus used for short-term borrowing and lending, often with a tenure from overnight to 48 hours.
Currently, the repo rate of the central bank is 5.75%. On 29 May of the fiscal year, it was 5%.
Although the crisis is clear, the Bangladesh Bank in November last year issued an urgent statement saying,"There is no liquidity crisis in banks."
