Lenders are sitting on the highest pile of excess liquidity in recent years and with no one to lend to, a development that has pushed down the interest rate on deposits and can fuel inflation
Last week, the Reserve Bank of India conveyed its intent to drain out excess liquidity from the banking system and resume normal liquidity operations given the evolving financial conditions.
As a first step, the Indian central bank drained out Rs 2 trillion of liquidity from the banking system via the 14-day reverse repo auction.
This begs the question: should the Bangladesh Bank kickstart a similar exercise as lenders here are sitting on the highest pile of excess liquidity in at least two years and with no one to lend to?
Earlier in July, with the view to steering the economy away from a steep downturn, the BB rolled out a vastly expansionary monetary policy for fiscal 2020-21.
It slashed the repurchase agreement (repo) rate -- which is the rate that is used to signal the central bank’s monetary policy stance -- by 50 basis points to 4.75 per cent. Before the pandemic began in March, it was 6 per cent.
The BB also cut the reverse repo rate by 75 basis points to 4 per cent and the bank rate by 100 basis points to 4 per cent.
A reverse repo agreement is the purchase of securities with the agreement to sell them at a higher price at a specific date in future. In Bangladesh, banks deposit their money with the central bank at a rate set by the latter.
The bank rate, which is another major tool of the central bank, was cut after 17 years as part of the expansionary monetary policy. The BB, on the whole, uses the rate while giving out money to banks under its refinance scheme.
Earlier in March, the central bank had cut the cash reserve ratio and credit-deposit ratio to prevent the economy from crash landing for the countrywide shutdown enforced by the government to flatten the curve on coronavirus between March 26 and May 30.
Besides, the BB is also injecting funds to the financial sector by way of implementing the stimulus packages.
All in all, it appears the banking system is awash with liquidity now, as a result of which savers are being short-changed.
As of November last year, the weighted average interest rate on deposits of banks stood at 4.6 per cent, in contrast to 5.7 per cent a year earlier, according to data from the BB.
Imports sharply fell, especially of lifestyle products amid the pandemic, which has helped to increase the liquidity in the banking sector, said Emranul Haq, managing director of Dhaka Bank.
Import payments amounting to $20.2 billion were made between July and November, down about 8.84 per cent from a year earlier, according to data from the BB.
The surge in remittance inflows are also helping to boost surplus liquidity in the sector, he added.
Remittance inflow to Bangladesh witnessed a massive growth of 37.6 per cent in the second half of 2020 from a year earlier.
“The surge in surplus liquidity is not a good sign for the economy,” Haq said, adding that the central bank should take an immediate initiative in this regard.
However, BB officials said there are no such plan to mop up the excess liquidity from the banking system.
The reason being, the private sector credit growth is not picking up, which was the intent for flooding the economy with liquidity.
In November, private sector credit growth stood at 8.21 per cent, which is way lower than the BB’s target of 14.8 per cent for this fiscal year.
There is surplus liquidity in the banking sector but people still have a shortage of funds, a BB official said requesting anonymity as he is not authorised to speak with media.
“Now is not the time to use the reverse repo as the excess liquidity has not yet created a risk to inflation,” said Zahid Hussain, a former lead economist of the World Bank’s Dhaka office.
The average inflation rose to a three-year high of 5.69 per cent in 2020 despite the consumer price index sliding to a 47-month low of 5.29 per cent in December, according to data from the Bangladesh Bureau of Statistics.
The demand for credit will increase in the upcoming days to keep pace with the economic recovery, said Hussain, adding that the excess liquidity will come down then.
The government borrowing from the banking system is not increasing due to the slow development spending from the government’s fund, which is another reason for the rising trend of excess liquidity in the banking sector.
The excess liquidity will come down when the government’s bank borrowings increase in the second half of the fiscal year, he added.
Atiur Rahman, a former BB governor, echoed the same.
“The expansionary monetary policy should be continued for the next six months as our economic situation is still uncertain owing to the ongoing pandemic.”
The central bank also extended its monitoring to ensure that the money reaches the COVID-19-affected and productive sectors through stimulus packages, he added.
Surplus liquidity is a bad indicator for the economy, said Salehuddin Ahmed, another former governor of the central bank.
The central bank should have utilised the liquidity through the implementation of the stimulus packages but it failed because most of the small and medium businesses were deprived of the stimulus funds, he added.