Dilemma with Interest Rate in Bangladesh

Dr. Mir Obaidur Rahman

14 June, 2017 12:00 AM printer

Dilemma with Interest 
Rate in Bangladesh

Dr. Mir Obaidur Rahman

Simply stated interest rate is the cost of capital. As a depositor when you keep money in a bank, the bank pay you interest as a premium on deferred consumption and when you borrow money, the bank lend money at a higher interest rate than the deposit rate. The margin is to defray various management costs and the difference is known as the spread. When interest rate on deposit is low and is less than the inflation in an economy, the depositor receives less money in worth. Ultimately it discourages the savings or deposits in both banking and non-banking financial institutions. Again, interest rate is crucial for investment. Higher interest rate discourages investment. When a project is not viable at 10 percent interest rate, it may be viable at 5 percent interest rate. So on both counts as an incentive to savings mobilization and also as an incentive to investments, rate of interest is crucial both for savers and investors.  

Rate of interest is linked to inflation in an economy. When an economy experiences higher inflation, the deposit rate should be higher than the inflation to make the real interest rate positive. A positive real interest rate gives incentive to saving and helps to tame the inflation. The bilateral exchange rate is also linked to inflation and an economy with higher inflation always witness depreciation of currency that makes import expensive and as a cyclical process fuel inflation.

The interest rate dilemma in Bangladesh has three facets. First, there are now excess savings in the banking sectors so with this idle savings financial institutions are reluctant to pay higher interest rate on deposit that make the real interest rate positive. With current inflation around 5.5 percent and interest rate on deposit in the neighbourhood of 6 percent, the depositor looks for alternatives and one alternative is the savings certificates where the interest rate is relatively higher. Government borrows money through these savings instruments and pay interest rate higher than the interest rate deposit in banking and non-banking financial institutions. The government borrowing from savings certificates stood at Tk 29,000 crore in July- January of the current fiscal year against its borrowing target of Tk 20,000 crore. This duality in interest rate hampers the smooth process of modernisation of the financial sector and result in distorted market structure. The financing of deficit through higher interest rate is a concern when funds are available at a lower interest rate and thus begs a question on the rationale of these instruments.

Secondly, the default loan in many sate-owned banks [to the extent of above Tk. one lakh crore] and the provisioning of the loan through the depositors savings and siphoning of fund through the public exchequer should cause higher interest rate. It is a riddle that interest rate instead of higher is now lower in financial institutes and surprisingly the next year’s budget proposes an excise duty on term deposit. Paradoxically, excess savings in the financial institutions constitutes a demeaning factor of lower interest rates. There is serious miss-match in this macroeconomic paradigm and needs to be sorted out.

Thirdly, the higher interest rate in savings certificate needs a careful look both on the purpose and utility of those instruments. One of the instruments known as the pensioner’s scheme was designed to help the retired officials to assure them a reasonable income to support a decent life.   Once the government decides a parallel rate on those saving instruments; it would constitute a serious threat on their living standards unless certain devices akin to western world such as social security benefit are designed for these groups of people. It is true that interest income in many western worlds is now low but retired people in those countries enjoy certain types of social service benefit. “The authorities could consider whether there are better targeted and less costly alternatives that achieve the government’s social policy goals without distorting financial markets.”

Lower interest rate that works as an incentive for investment, also works for the development of a capital market vital for financing the long-term private investment. An interest rate that works as an incentive both for the investors and the savers is feasible only when savings find a healthy environment for investment. The constancy of GDP growth and the constancy of investment as percentage of GDP is a manifestation that the country requires adequate infrastructure both physical and institutional to augment investment to reach the middle-class status in the near future. On a historical basis, national savings always lags behind national investment and the leakages obviously get an outlet in abroad in a fancy name.


The writer is a Professor of Economics, United International University