Bangladesh Bank is set to give loans to local banks’ offshore banking units (OBU) to offset the negative returns that it now gets for its liquid euro assets -- a move that can be viewed as making the best out of a bad situation.
Interest rates went negative in the eurozone in June 2014 and the European Central Bank is widely expected to lower the negative interest rates even further today.
At present, the Euro Interbank Offered Rate (Euribor) ranges from -0.358 percent to -0.452 percent.
“This is causing erosion of euro liquid assets,” said Zahid Hussain, former lead economist of the World Bank’s Dhaka office.
Meanwhile, OBUs of domestic banks have borrowed from banks in the eurozone at 2-5 percent interest rate, and the interest payments are counted as outflows of foreign exchange from Bangladesh.
As of June, €412 million has been borrowed by local banks’ OBUs from the eurozone, according to data from the Bangladesh Bank.
Subsequently, directors of the BB have decided to lend to the local banks’ OBUs from the portion of its reserves it would invest in Euribor-linked products.
A guideline will now be chalked out to execute the plan.
“The decision was taken for the good of the country,” said Kazi Sayedur Rahman, executive director of the BB.
Banks are borrowing at 5-6 percent from the eurozone whereas the market rate is negative, he said.
The central bank would lend to the OBUs at lesser interest rates, so importers would be benefitted. “So instead of outflows there would be profits for us,” he added.
Hussain echoed the same. “There is a potential win-win situation.”
However, there are caveats.
Doing so would amount to reducing official foreign exchange reserves, he said.
“Because, investment in non-tradable domestic claims, even if it is in euro, cannot count as foreign exchange reserves.”
Official reserve assets normally consist of liquid or easily marketable foreign currency assets that are under the effective control of, and readily available to, the monetary authority.
This will not have been a concern were there excess foreign exchange reserves, Hussain said.
As of September 4, foreign exchange reserves stood at $32.80 billion, enough to cover about five-and-a-half months’ import bill, according to data from the central bank.
Given that the BB intervenes in the foreign exchange market to keep the exchange rate relatively stable against the US dollar, assessment by the International Monetary Fund suggests an adequacy ranging from 3 to 8.8 months of imports given the country-specific characteristics of Bangladesh.
“Fact is we don’t,” Hussain said, adding that import growth is outstripping export growth.
Liquidating foreign exchange reserves on grounds of marginally negative return when its level is barely adequate undermines a key rationale for holding reserves: to enable the economy to absorb unforeseen external or domestic shocks.
He instead suggested switching to alternative foreign assets to offset the negative returns on euro liquid assets.