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Bank Parikrama
Volume XXX, No.1, March 2005(pp. 69-86)
Is Investment Demand Sensitive to Interest Rate in
Bangladesh? - An empirical Analysis
- Md. Ezazul Islam ∗
- Mst. Nurnaher Begum ∗
Abstract
The main objective of the paper is to estimate investment demand function and to see the
policy implications of monetary policy. By using OLS method, an investment demand
function has been estimated for the sample period of 1973-2004. From the estimated
investment demand, it is found that investment is more sensitive with GDP by 1.61
percent and less sensitive with interest rate (real lending rate) by 0.36 per cent. With
narrow based capital market, financial sector specially banking system is major source
of investment financing. Despite lower sensitivity of investment with respect to interest
rate, there are some implications for perusing expansionary monetary policy to induce
firms to desire more capital with lower cost. The trend of financial deepening and ratio
of private sector credit to GDP indicates a close link between financial development and
economic growth in Bangladesh. For achieving higher growth say 8-9 per cent yearly,
expansionary monetary policy is effective with prudent fiscal policy.
1. Introduction
In order to reduce financial intermediation cost, financial sector reforms
project was under taken in the early 1990s. Under the interest rate liberalization
policy, banks and financial institution enjoy full freedom to fix deposit and
lending rate in the financial market. High lending rate in Bangladesh has
recently appeared as a constraint of financing investment project. Economic
theory tells that business man will invest in projects where the expected benefits
exceeds the cost of investment. But this efficient outcome can be achieved only
when entrepreneurs face no credit constraints. Credit constrains, poor access to
credit (especially long-term credit) and high cost of borrowing, are less likely in
countries with well-developed and well- functioning financial system. A healthy
financial system, by freeing firms from financial constrains, allows
entrepreneurs to expand their business according to their expected potential
∗
The authors are Joint Director and Deputy Director, Research Department, Bangladesh Bank, respectively.
Views expressed in this article are authors’ own and do not represent those of the Bangladesh Bank. Authors
are grateful to Dr. Toufic Ahmad Choudhury, Professor and Director of BIBM and Dr. Ding Lu, Professor,
Singapore National University for theirs valuable comments.
70
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rather than their current stock of cash. Generally, high lending interest rate
means higher cost of capital. Higher cost of capital reduces return of capital,
which ultimately, lower the profit margin of investors. If the high lending rate
persists, investment demand will decrease and ultimately growth will be slowed
down. So reasonable interest rate is necessary for saving mobilization, capital
accumulation and economic growth in Bangladesh like other developing
countries. Interest rate is the price of the intertemporal allocation of goods and
thereby determines saving, investment and ultimately, economic growth
(Christian et. al. 2003).
In recent time, some studies and documents1 reported that the lending
rate is high in Bangladesh as compared to some of the Asian countries. Since
then, the issue of high lending rate has widely been discussed among policy
makers, investors, bankers and business communities. But these studies mostly
concentrated on interest spread and there is hardly any discussion of relation
between interest rate and investment financing. Actually, it is necessary to
identify the extent by which interest rate affects the investment finance in
Bangladesh and also find out whether high interest rate really is constraint to
investment. In this backdrop, this paper attempts to quantify the relationship
between investment demand and interest rate. The paper also tries to give some
policy implications.
2. Financial Development and Economic Growth of Bangladesh
A number of studies demonstrates a strong, positive link between
financial development and economic growth, and there is even evidence that the
level of financial development is a good predictor of future economic
development (Ross, 1997). There are many measures of financial development
in the literature of financial development. Out of these measure, two most
important measures of financial sector development of Bangladesh are given in
Table 1. Financial deepening (M2/GDP) was, on average, 14.73 per cent in
1970s which grew over time and stood at 36.85 during FY 2001-2004. On the
other hand, private sector credit/GDP ratio, a good measure of banking level
1
Wareen Coats and Jahangir Alam (2003), Choudhury A Quadir (2003), Mahmud, Wahiduddin (2004),
Mazid Kazi (2003) Md. Abdul Maleque (2004), Bangladesh Economic Update, World Bank (May 2004), and
Bangladesh Public Expenditure Review , WB and ADB (June 2002).
71
Islam & Begum: Is Investment Demand
development, was on average 4.57 per cent which grew sharply overtime and
stood at 25.25 percent during FY 2001-2004. Year-wise trends of the two
measures are given in Chart 1. McKinnon (1991) argues that a high and rising
M2-GDP ratio indicates a large flow of domestic loanable funds for new
investment. Ross (1997) shows that there is a positive and statistically
significant correlation between real per capita GDP and the extent to which
loans are directed to the private sector.
Table 1 : Financial Sector Development Indicators
Year
M2/GDP
Private Sector Credit/GDP
1970s
14.73
4.57
1980s
23.72
14.81
1990s
30.93
20.50
2001-2004
36.85
25.25
Source : Economic Trend, Bangladesh Bank.
Figure 1: Trend of Financial depeening
50
As percentage go GDP
40
30
20
10
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
0
M2/GDP
Private sector credit/GDP
Source : Economic Trend, Bangladesh Bank.
Recently, Bangladesh has achieved higher GDP growth on average
around 5.13 per cent during 2001- 2004 period, as compared to 2.82 per cent in
1970s, 3.85 per cent in 1980s, and 4.73 per cent 1990s. Rate of inflation, on
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average basis, came down to around 3.73 per cent during 2001-2004 period as
compared to 16.76 per cent in 1970s, 10.84 per cent in 19980s and 4.83 per cent
in 1990s.
It is revealed from the cross country economic growth data that high
investment-GDP ratio lead to high economic growth (Dornbusch , 2001).
Investment –GDP ratio is still lower in Bangladesh as compared to the many
Asian developing country like Singapore, Malaysia, Taiwan, Hong Kong and
South Korea, where extraordinarily high rate investment of 35-40 percent of
GDP are being maintained. However, investment / GDP ratio in Bangladesh
rose to 23.23 percent in 2004 from 9.48 percent in 1970s (Table-2 ).
The emerging consensus view is that, to reduce the incidence of
Bangladesh’s poverty from its present level of 35 percent to 10-15 percent as in
East Asian countries, it needs to attain and maintain a steady economic growth
of about 8-9 percent per annum for the next 15-20 years (Hussain, 2004). As
Bangladesh is at an early stage of development with surplus labor, a high rate of
capital accumulation could be the key source of high economic growth. As
happened in East Asia, a high rate of physical investment was matched with
both skilled and unskilled labor and raised economic growth, even if there was
only limited total factor productivity growth in the absence of research and
development. The latter source of growth (total factor productivity) would
become significant at a later stage when the economy will have reached a higher
state of economic and social development.
Over the past two decades, government investment ratio remained at
around 6.5 per cent. On the other hand private investment increased
tremendously to 16.83 percent from 7.16 per cent in 1990s. The government,
recognizing the private sector as the major driving force of the market economy,
is committed to take supportive steps towards enhancing the involvement and
active participation of the private sector in the overall development activities of
the country. Consequently, reform and liberalization programmes have been
made more functional and effective to strengthen the structure of the market
economy as well as to develop an efficient private sector. Government is now
changing its stand from the role of a regulator to that of a facilitator and partner.
73
Islam & Begum: Is Investment Demand
Table 2 : Average Investment -GDP Ratio
(In percentage)
Period
1973-1980
1981-1990
1991-2000
2001-2004
Government
Private
Investment/GDP Investment/GDP
4.45
5.03
6.23
7.16
6.49
12.19
6.48
16.83
Total
Investment /GDP
9.48
13.39
18.67
23.30
Source : 1. BBS: Twenty Years of National Accounting of Bangladesh, July, 1993.
2. GOB: Economic Survey. 2004.
The evidence from the vast literature on growth empirics shows that
investment in capital goods as one of the most robust determinants of crosscountry growth (see, Levine and Renelt, 1992, Durlauf and Quah, 1999). Over
the last couple of decades, economic liberalization and deregulation policies
have been widely adopted by developing countries that assign a central role to
the private sector. The emphasis on the private sector as the engine of economic
growth and development has brought the focus on the behavior of private
investment in developing countries2.
Although the current investment rate is significantly higher than that in
the 1970s and 1980s, it is much lower than what is required to attain and
maintain an economic growth of 8-9 percent per annum. The trick of high
economic growth in North and South –East Asian countries, such as Singapore,
Malaysia, Taiwan, Hong Kong and South Korea, was extraordinarily high rate
investment of 35-40 percent of GDP. Despite low productivity growth, such
investment contributed most to the annual average economic growth rate of
about 8 percent over 20 years (Hossain and Chowdhury, 1998). A steady
economic growth of this magnitude reduced the incidence of poverty in these
countries to a single digit level.
Therefore the major challenge for Bangladesh is to raise investment to
the level of at least 30 percent of GDP. While this might appear as a reasonable
proposition, it could be difficult because there are various implications of
2 See, for example, Fielding (1999) on South Africa and Guncavdi, et al. (1998) on
Turkey.
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additional investment financing from both domestic and foreign sources. The
primary sources of external funds for business throughout the world are loans as
for example, the share of bank’s loan to business financing is 61.9 percent in
USA (Mishkin, 2000). There is no comparable data relating to external business
financing that is share of banks loan to business in Bangladesh. But, the banks
and financial institutions are, still , the major sources of investment financing in
Bangladesh due to narrow based capital market . As for example, disbursement
of industrial terms loan by the Banks and financial institutions stood at Tk. 66.2
billions, many fold higher than the amount of Tk. 2.4 billions raised by new
capital issues through private placements and public offerings in the capital
market in FY 04 (Table 3).
Table 3 : Industrial Term Loans of Banks and Financial Institution,
(in Billion Taka)
Disbursement
Recovery
Outstanding (End June)
FY 01
30.57
27.95
153.79
FY 02
35.2
32.1
166.8
FY 03
39.6
38.4
184.3
FY 04
66.2
49.4
195.4
Source : Bangladesh Bank.
Cross country comparisons show that financial sector of Bangladesh is
relatively shallow. According to world bank data, bank credit to private sector
was just 29 percent of GDP and broad money was 37 percent of GDP in
Bangladesh (Table 4). The World Bank (2004) identifies that quality of
financial intermediation is relatively weak which is impacting growth in
Bangladesh.
A survey report3 shows that firms in Bangladesh collect around 55
percent of their working capital and nearly 60 percent of their investment
capital, on average, from their retained earning, while about 30 percent of
working and investment capital from banks (Table 5). The survey report also
indicated that many firms appear to have exhausted the bank credit available to
them, financing is primarily short term, and its cost is high. Real borrowing rates
3
See the report “Improving the Investment climate in Bangladesh, World Bank and
Bangladesh Enterprise Institute, June 2003, PP. 32-33.
75
Islam & Begum: Is Investment Demand
have sometimes exceeded 10 percent in the past decade (World Bank, 2003).
The banking system is dominated by four large national commercial banks,
which create instability and stifle competition. There are many constraints in
operation of firms in Bangladesh. Among the constraints, access to financing
and cost of financing are most significant to 41.5 percent firms and 49.8 percent
firms respectively (Table 6).
Private
Credit/GDP
Bank
Concentration
Ratio
Stock Market
Capitalization
to GDP
Lending Rate
Minus Deposit
Rate
Real Interest
Rate (%)
Bangladesh
Chile
China
India
Indonesia
Malaysia
Niger
Sri Lanka
Thailand
Vietnam
M2/GDP
Table 4 : Financial Sector Indicators: Cross Country Comparisons
37.02
44.73
167.58
57.99
53.68
100.27
9.02
36.76
98.54
49.9
29.07
66.41
139.67
31.74
22.28
145.23
5.01
28.25
102.92
43.1
0.43
0.23
0.52
0.48
0.53
0.3
1
0.52
0.31
0.71
0.02
0.75
0.5
0.21
0.08
1.32
0.05
0.26
-
7.34
5.7
3.6
3.07
3.29
8.38
4.71
4.12
12.95
5.03
6.55
7.61
10.99
2.59
5.51
6.09
5.56
Source : World Bank Data.
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High-capacity
Exporter
Low-Capacity
Large
63.9
55.5
52.2
53.9
56.8 55.8
50.3 50.7 58.1
5.1
25.8
35.5
35.7
33.3
33.5 33.2
43.0 39.9 30.3
Trade credit
4.2
4.6
2.0
3.9
5.2
5.3
3.4
4.2
4.0
4.7
3.9
Equity
0.5
12.7
0.3
0.3
0.7
0.7
0.4
0.4
0.7
0.5
0.5
Informal sources
0.5
1.3
1.1
0.2
0.3
0.3
0.6
0.5
0.1
0.4
0.5
All others
Sources of New
Investments
5.8
10.9
6.9
4.5
5.8
6.5
5.3
5.9
1.9
3.7
6.8
Retained earnings
59.9
Banks and other
financial institutions 29.7
55.6
68.0
61.2
55.9
55.5
62.9 59.6
62.8 54.8 52.3
6.2
20.0
30.1
33.6
33.0
27.4 29.8
30.7 36.3 26.5
Trade credit
2.6
1.7
2.7
2.1
2.8
3.0
2.4
2.7
1.1
2.4
2.7
Equity
0.4
14.1
0.2
0.2
0.5
0.6
0.2
0.3
0.0
0.6
0.3
Informal sources
0.3
2.6
1.1
0.2
0.1
0.2
0.5
0.4
0.0
0.2
0.4
All others
7.1
15.4
8.1
6.1
7.1
7.7
6.7
7.3
5.5
5.7
7.8
Foreign
Medium-size
65.4
Domestic
Small
Retained earnings
56.6
Banks and other
financial institutions 33.5
Bangladesh
Pakistan
Non-Exporter
Table 5 : Sources of Finance for Firms in Bangladesh, International
Perspective and by Type of Firms
(in percentage)
Sources for
working capital
Source : Investment Climate surveys, the World bank and Bangladesh Enterprise Institute, June, 2003.
77
Islam & Begum: Is Investment Demand
Table 6 : Share of Firms Assessing Constraints to Operation as Major
in Bangladesh, International Perspective and by Type of Firms
Exporter
Non-Exporter
Domestic
Foreign
Low-Capacity
High-capacity
24.3
31.0
28.1
22.5
9.2
16.5
Electricity
73.2
39.2
28.1
75.8 75.1 70.6
67.8
76.4
73.8
55.2
74.9
72.1
Transport
24.2
9.9
19.4
21.1 29.6 22.9
20.8
26.2
23.9
27.6
25.7
23.4
Access to land
27.5
20.4
16.3
28.1 33.3 25.7
26.0
28.4
27.3
34.5
30.2
26.1
Tax rates
35.4
45.6
34.1
32.6 40.8 33.3
26.7
40.6
35.4
41.4
40.1
32.9
Tax administration
Customs and trade
regulations
49.8
46.0
23.7
41.4 55.9 49.8
43.3
53.4
49.8
51.7
53.6
47.8
41.9
24.5
21.1
27.3 51.6 43.1
35.6
45.4
42.1
34.5
45.5
40.0
8.3
15.0
19.4
5.3
8.7
9.2
7.8
8.6
0.0
7.5
8.7
19.3
12.7
26.7
15.4 23.5 18.4
17.6
19.8
19.3
10.3
24.6
16.6
Large
24.4
Small
China
26.5
Pakistan
20.8
Bangladesh
Medium-size
( in percentage)
Constraints
Telecommunications
Labour regulation
Skills and education
of available workers
Business liencing
and operating
permits
19.8 30.0 23.0
10.8
16.5
14.5
15.9
11.0 19.2 17.5
17.8
15.4
16.7
10.3
17.1
16.1
Access to financing
41.5
37.5
24.1
41.4 53.5 35.9
35.9
44.7
42.2
20.7
51.2
36.6
Cost of financing
Regulatory policy
uncertainty
Macroeconomic
instability
49.8
42.6
21.6
47.1 55.4 47.8
43.1
53.7
50.0
48.3
58.1
45.6
44.4
40.1
28.0
35.7 55.9 42.0
37.4
47.8
44.1
51.7
50.3
41.3
corruption
Crime, theft, and
disorder
Anticompetitive or
informal practices
38.6
34.4
26.0
27.8 45.1 39.6
29.2
44.5
38.7
37.9
41.9
36.8
57.8
40.3
22.4
50.7 61.0 58.0
54.5
58.8
57.7
58.6
61.4
55.8
39.2
21.5
15.7
36.6 45.5 36.8
34.4
41.9
39.3
31.0
41.9
37.7
29.3
21.3
17.6
30.4 33.3 27.3
22.3
34.1
29.3
27.6
30.8
28.5
Source: Investment Climate Surveys, the World Bank and Bangladesh Enterprise Institute, June, 2003.
3. Model Specification, Methodology and Data
a. Theoretical Aspect of Investment
Broadly there are three investment sub-sectors: business fixed
investment, residential investment and inventory investment. Here, overall
investment is considered to estimate investment demand. The theory of
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Bank Parikrama
investment is the theory of the demand for capital. Generally we define
investment (I) as I= K-K-1 . Where K is capital stock. The general relationship
among the desired capital stock, the rental cost of capital (rc, rate of interest) and
the level of output may be defined in functional form as follows:
K*= g(rc, Y) …………………………………(1)
where, an increase in the rental cost decreases K*, and an increase in GDP
increases K*. Having this simple theoretical background of the investment
demand, we may construct semi log linear investment demand function for
Bangladesh as follows:
LNTIR = α + β1 INGDPR - β2 RADI + ε …………….(2)
Where,
LNTIR= log of real total investment
LNGDPR = log of real gross domestic product.
RADI= Real weighted average lending interest rate.
ε = Stochastic term.
To estimate the investment demand equation, we have applied Ordinary
Least Square (O L S) method by using yearly data for the period 1973-2004.
Data have been collected from Bangladesh bank’s Annual Report, Economic
Trend, Economic Review of Bangladesh and Bangladesh Bureau of Statistics.
b. Unit Root Test
Augmented Dickey-Fuller (ADF) test of the variables is given in Table
7. According the ADF test, LNTIR and LNGDPR have unit root in level form
and non stationary. In first difference level, both variables are stationary. On the
other hand, RADI is stationary in level form. So, to avoid spurious regression,
we have take LNTIR and INGDPR in growth form to estimate investment
demand function as follows:
∆ LNTIR = α + β1 ∆ INGDPR - β2 RADI + ε ……………… (3)
4. Analysis of Estimated Results
a. Estimate Results
Detailed estimated results of investment demand function are
summarized in Table-8. According to estimated result, our investment demand
function is as follows:
∆INTIR = 0.5 + 1.61 ∆LNGDPR - 0.36 RADI-------------------(4)
79
Islam & Begum: Is Investment Demand
From the estimated equation we can see that investment elasticity with
respect to GDP is 1.61 which implies that if GDP increases by 1 per cent,
investment demand will increase by 1.61 per cent. On the other hand,
investment with respect to interest is inelastic and insignificant which indicates
that if 1 percentage point interest rate declines, investment demand will increase
by only 0.36 percent . Sultan Hafeez et, al. (1996) estimated private investment
function for Bangladesh. This study failed to identify the investment sensitivity
to interest rate because they did not include interest rate as an explanatory
variable in their model.
b.
Diagnostics Checking
It is not uncommon in applied econometric research to estimate a totally
meaningless model and yet obtain ‘correct signs’ and high/low R2. Sometimes
high R2 may result from spurious correlation arising from the model being
inappropriately specified (Granger and Newbold. 1974). Kramer et, al (1985)
suggest that conventional regression output should be supplemented by a score
of specification tests because this will make it harder for results to appear
significant due to a researcher’s intention or unintentional ‘data mining’. A
battery of diagnostic tests to support empirical results presented in Table 9-11.
These diagnostic tests indicate well- fitting investment equation that fulfill the
conditions of normality of residuals, serial non correlation of errors, structural
ability and Ramsey specification test.
Table 7 : Time Series Properties: Unit Root Test
Variable
Level
INTIR
INGDPR
RADI
Difference
∆ INTIR
∆ INGDPR
Test
t-value
1%
ADF
ADF
ADF
-2.24
-1.40
-8.90
-4.29
-4.29
-3.67
ADF
ADF
-3.65
-3.66
-4.30
-4.30
Critical value
5%
-3.56
-3.56
-2.96
-3.57
-3.57
10%
-3.2
-2.62
-2.62
-3.22
-3.22
Source: Estimated by authors
Table 8 : Estimated Investment Demand
∆INTIR =
t
R2
D.W
N
0.05
(1.27)
0.22
2.01
31
Source: Estimated by authors
+1.61 ∆INGDPR
( 2.82)
-0.36 RADI
(0.83)
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Table 9 : Diagnostic Test
Test Statistics
1. Coefficient Test
2. Serial correlation
Test
Wald test
Bruch-Godfrey
F
3.98
1.19
P
.03
0.32
3. Specification Test
4. Parameter Constancy Test
5. Residual Normality Test
Ramsey Reset Test
Chow Test (1990)
Jarque- Bera
1.73
2.59
36.76
0.19
0.07
0.00
Source: Estimated by authors
Table 10 : Correlogram of Residuals
Lag
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Auto Correlation Partial Auto
Correlation
-0.177
-0.177
0.243
0.218
-0.037
0.038
-0.022
-0.081
-0.138
-0.167
0.078
0.067
-0.065
0.031
-0.093
-0.152
-0.125
-0.200
-0.178
-0.204
-0.068
-0.041
-0.059
-0.020
0.146
0.124
-0.052
-0.058
0.065
-0.084
0.017
0.020
Source: Estimated by authors
Q-Statistics
Probability
1.0740
3.1517
3.2024
3.2209
3.9685
4.2159
4.3969
4.7840
5.5156
7.0605
7.2948
7.4814
8.6943
8.8594
9.1311
9.1497
0.300
0.207
0.361
0.522
0.554
0.647
0.733
0.780
0.787
0.720
0.775
0.824
0.796
0.840
0.871
0.907
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Islam & Begum: Is Investment Demand
Table 11 : Correlogram Residuals Squired
Lag
Auto correlation
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
0.021
0.093
-0.081
0.050
-0.068
-0.036
-0.079
-0.064
-0.026
-0.034
-0.086
-0.051
-0.006
-0.040
-0.077
-0.082
Partial Auto
Correlation
0.021
0.093
-0.086
0.046
-0.056
-0.049
-0.058
-0.067
-0.012
-0.034
-0.094
-0.050
-0.008
-0.059
-0.095
-0.096
Q-Statistics Probability
0.0155
0.3228
0.5647
0.6605
0.8439
0.8960
1.1596
1.3425
1.3745
1.4320
1.8139
1.9525
1.9545
2.0519
2.4300
2.8840
0.901
0.851
0.904
0.956
0.974
0.989
0.992
0.995
0.998
0.999
0.999
0.999
1.000
1.000
1.000
1.000
Source: Estimated by authors
5.
Policy analysis and conclusion
Under the deregulated interest rate regime, Bangladesh Bank influences
lending, deposits and call money rates through monetary instruments viz. Bank
rate, Statutory Liquidity Ratio (SLR), Cash Reserve Requirement ( CRR), Repo
and Reverse Repo. There is a positive movement among the bank rate, deposit
and lending rate (Figure 2). With the aim of reducing interest rate at desired
level, Bangladesh Bank reduced bank rate gradually to 5 percent in November
2003 (effect from 8.11.03) from 8 percent in 1997. Bangladesh Bank also
reduced SLR to 16 percent from 20 percent in November 2003. Along with
these, cash reserve requirement (CRR) has also declined to 4 percent. Savings
certificate rates were also reduced by 2 percentage point during the last years.
Despite these policy measures taken by the central bank and GOB, the
commercial banks did not response quickly it rather responded slowly.
However, these measures had a little impact on lending rates (Table-12). Still in
Bangladesh, the real interest rate is high as compared to some of the Asian
counties and there is ample opportunity to reduce lending rate.
82
Bank Parikrama
Table 12 : Movements in Selected Interest Rates
Bank rate
Treasury bill rates
28-day
91-day
182-day
364-day
Call money rate
Borrowing
Lending
Scheduled banks rate
Deposits
Advances
Commercial Lending
Deposits
Advances
2000
7.00
2001
7.00
2002
6.00
2003
6.00
2004
5.00
6.10
6.30
7.00
7.70
6.10
6.80
7.10
7.40
4.80
5.30
5.50
5.70
7.00
8.80
9.30
9.90
4.00
4.00
6.00
6.30
7.40
7.80
8.20
11.00
9.30
9.10
10.80
12.10
4.40
5.40
7.20
13.90
7.00
13.80
6.70
13.20
6.30
12.80
5.70
11.01
8.64
13.03
8.85
12.62
9.12
13.02
7.51
12.24
5.84
9.91
Source : Bangladesh Bank Annual Report 2003-2004.
Chart 2 : Movement of Bank Rate, Weighted
Average Deposits and Lending Rate
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
16
14
12
10
8
6
4
2
0
Bank Rate
Lending Rate
Deposits Rate
83
Islam & Begum: Is Investment Demand
According to a CPD study4 the government resorted to vigorous ‘moral
suasion’ in FY 04 in order to bring down the lending rate of bank loans. CPD
undertook a rapid perception survey regarding the realized benefits of the
declining rate of interest (lending) in the banks in terms of production cost. As
per the survey report, about 62 percent entrepreneurs (number of responded was
86) acknowledged that the reduction in the rate of interest rate has benefited
their companies in terms of reduced production cost. However, about 38 percent
entrepreneurs are yet to receive such benefit.
The widespread culture of loan default has resulted high cost of
financial intermediation, as reflected in the large spread between the deposits
and lending rates of interest. The resulting high cost of borrowing increases cost
of capital which discourage private investment. Whahiduddin Mahmud (2004)
and Warren Coats (2003) observe that high non performing loan is the main
obstacle to reduce high lending rate. The earlier regime5 interest rate policy was
based on the belief that credit can be best allocated by the government’s dictates.
The new liberalized system is based on the hypothesis that deposits can get a fair
return and credit can be allocated more efficiently through the liberalization of
financial mediation. The actual results of financial liberalization were, however
different from those envisaged. Whahiduddin Mahmud (2004) argues that
Bangladesh adopted financial liberalization without preparing for adequate
regulation and supervision. Recently, Bangladesh Bank has strengthened
regulation and supervision by adopting different amendments. As a result, ratio
of non performing loan has been declining gradually (Table 13).
Table 13 : Ratio of Non Performing Loan (%)
Bank Types
NCBs
DFIs
PCBs
FCBs
Total
1997
36.57
65.72
31.42
3.58
37.49
1998
40.38
66.7
32.72
4.14
40.65
1999
45.62
65.02
27.09
3.8
41.11
2000
38.56
62.56
22.01
3.38
34.92
2001
37.02
61.8
16.98
3.33
31.49
2002
33.73
56.19
16.38
2.61
28.01
Source : Bangladesh bank, Annual Report 2002-2003 and 2003-2004.
Note : NCB= Nationalised Commercial Bank, DFI= Development Financial Institution,
PCB= Private Commercial Bank and FCB=Foreign Commercial Bank
4
5
Business Competitiveness Environment In Bangladesh, 2004.
Since independence up to 1990s.
2003
29.0
47.4
12.4
2.7
22.1
84
Bank Parikrama
Despite lower sensitivity of investment with respect to interest rate,
there are some implications for perusing expansionary monetary policy by
cutting Bank Rate further for achieving higher investment –GDP ratio. Shah
Emran et, al (2003), estimated investment function for India by using ARDL
method and found that the response of private investment with respect to the
relative cost of capital ( interest rate) increased at least five times. So monetary
policy affects capital demand by affecting the market interest rate. A lowering of
the nominal interest rate by the bank induces firms to desire more capital. This
expansion in capital demand, in turn, will affect investment spending.
In the absence of developed capital market, credit flow (both term loan
and working capital) from banking system is essential for firm’s investment
financing in Bangladesh. The growth of financial deepening and private sector
credit (private sector credit/GDP) indicates a close link between the financial
system and economic growth in Bangladesh.
As direct controls over interest rates have been relaxed, interest rates
have begun to play a greater role in transmitting monetary effects to the real
sector of the real economy. Investment is a principal conduit of monetary policy
into the goods markets. Interest rates are a prime determinant of the cost of
owning capital. Liberal / expansionary monetary policy lowers interest rates,
lessens the cost of owning capital, and increases the demand for capital. So, for
achieving higher growth say 8-9 per cent yearly, expansionary monetary policy
( higher private sector credit allocation by reducing interest rate ) is effective
with prudent fiscal policy .
Islam & Begum: Is Investment Demand
85
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