Private credit growth hits historic low. What does it mean?

Private sector credit growth fell to 4.72 percent -- a record low -- in March, marking another month of slowdown.

The downturn in loan flow was recorded at a time when Bangladesh elected a new government for five years after the general election, which many thought would bring an end to the dry spell in private investment.

The latest data has dampened those expectations. Rather, it has raised questions about what has gone wrong.

The obvious answer is the US-Israel war on Iran and the consequent closure of the Strait of Hormuz, a key maritime chokepoint, by Iran and its ripple effects on the global economy. Oil prices, as well as gas, fertiliser and various other commodity prices jumped, unnerving investors.

Many investors who planned to make a fresh start after the election held back amid an uncertain global economic environment, risks of imported inflation and worries over the war fallout on Bangladesh’s economy, a net import-dependent country.

“None invests under such an unstable environment,” said Taskeen Ahmed, president of the Dhaka Chamber of Commerce and Industry.

The record-low credit growth, he said, reflects that investors are “downbeat” because of the economic pressure since the Covid-19 pandemic. The Russia-Ukraine war, worsening energy crisis, persistent inflation and rising interest on bank loans were some of the challenges they faced over the last few years.

The war has added a fresh concern for entrepreneurs. So, this low credit growth is a culmination of all these factors, Ahmed said.

Sohail R K Hussain, Managing Director of Bank Asia PLC, said many investment decisions have been deferred as investors fear that the local currency may be devalued further, since several countries have devalued their currencies against the US dollar amid global uncertainty.

He added that during the last seven to eight years of the Awami League-led government, there was excessive lending to some large borrowers; as a result, the market is now correcting, and demand has weakened.

Mir Nasir Hossain, former president of the Federation of Bangladesh Chambers of Commerce and Industry, said the slowing credit flow is bad for investment and employment.

One main factor is soaring interest rates, which has made borrowing costly not only for fresh loans but also for existing loans. Banks are also reluctant to extend commercial loans. Many make hefty profits by investing in government bonds for secure returns.

For Hossain, the latest private credit growth data is an ominous sign. “It is really very concerning.”

Abdur Razzaque, chairman of Research and Policy Integration for Development, echoed similar concerns. To him, the exceptionally weak private sector credit growth is a critical warning sign of a deeper private investment crisis.

“It reflects a unique situation in which firms are reluctant to expand, banks are increasingly constrained or unwilling to take credit risks, borrowing costs remain high, public borrowing is absorbing financial space, and uncertainty over energy, inflation, external conditions and the exchange rate continues to weigh on business decisions.”

A number of factors -- rising non-performing loans, provisioning pressure, undercapitalisation, fragile depositor confidence and liquidity constraints -- have weakened banks’ capacity to lend, while uncertainty over borrower quality has reduced their willingness to extend fresh credit.

“In effect, the banking system is becoming more defensive. It is protecting its balance sheets rather than supporting new investment.”

Razzaque said the overall situation is quite unusual as Bangladesh is facing both weakened demand for credit and a lacklustre supply response from the banking system.

“This combination risks pushing the economy into a low-equilibrium trap: firms are not investing because confidence is weak, banks are not lending because risks are high, production remains subdued because investment and imports are compressed, and slow activity then further weakens the case for new lending. Breaking this cycle will require more than marginal changes in credit targets.”

However, Md Ezazul Islam, director general of Bangladesh Institute of Bank Management, said credit demand will pick up from April to May as political stability returns. “It seems that the sluggish phase has bottomed out,” he said.

However, Razzaque said the recovery of private sector credit growth will remain difficult unless the government recognises the wider consequences of excessive borrowing from the banking system.

“When public borrowing offers banks a safer and easier return, private enterprises are pushed further to the margins. Restoring credit growth, therefore, requires not only lower inflation and a more stable exchange-rate environment, but also credible banking-sector repair, disciplined public borrowing, improved confidence, and a clear policy signal that productive private investment will again be treated as the central engine of growth.”

He said the government and the central bank should increase lending to the small and medium enterprise (SME) sector at low interest rates under refinance schemes.

He also said ongoing legal reforms could help improve the investment climate further.