Disclosure: The article was written on Thursday, January 13, 2011 at 10:47pm. It reflects the writer's personal opinions based on own analysis. The writer is not responsible for decisions taken on the basis of this article. Send your views at kh.asif@gmail.com.
Recently the drastic fall in the stock index made headlines and became a much talked about issue. A large amount of blame was put on the stock market regulator and the government. However, the biggest blame was on the Bangladesh Bank which decided to increase the Cash Reserve Ratio from 5.5% to 6%. According to financial market “experts”, the increase in CRR caused a liquidity crisis in the money market which ultimately led to the stock market sale pressure (which off course led to panic sale).
Without going into all these arguments about who is to blame I would rather focus on the money market situation. As per newspaper reports, because of the hike in CRR the central bank took out BDT 2,000 crore from the system. A similar amount was brought out through issue of government securities. However, the Bangladesh Bank claimed that they had injected more than 20,000 crore to the system through repo financing. So in simple math (20,000-2,000-2,000=16,000).
If 16,000 crore (net) has been added to the system then definitely the fund crisis that banks and other financial institutions were in should have been resolved. The funny thing is that the crisis is not over. Even though the call money rates have come down, most financial institutions are still in a fund crisis. This is EXACTLY why stock brokerages and merchant banks are unable to give margin loans to their clients. If banks dont have money, then brokers and merchant banks also do not have money. If the brokers and merchant banks actually had money they would have definitely given out loans because that is how they make profit. Unfortunately neither the media understands this nor does the retail investors. While one segment is busy breaking offices the other is adding fuel to the fire by making illogical media reports. At the same time the SEC increased the margin loan ratio from 1:1.5 to 1:2 in a period when most brokers can’t even provide 1:0.6. What I don’t further understand is, in such a volatile (and off course highly overvalued market) why the hell would someone need additional margin loan? I guess the general investors know more about stocks than me, so I will leave it to that.
Now there has to be a reason why the liquidity crunch has not been resolved in spite of BB injecting more funds, banks increasing deposit rates (to attract more deposits), financial institutions liquidating part of their portfolio etc. At first I thought that maybe the CRR hike led to a reverse multiplier effect on the money supply. The mistake in this logic was that it would actually take some time for the reverse to occur and off course the magnitude would not be as big as I thought (pointed out by my colleague Ali bhai).
Now what happened in reality (this is still a hypothesis) was that we were seeing rapid increase in imports (in a period when remittance growth was negative). For quite some time, the banks were using deferred LC’s to finance these imports. This meant that they were only buying the dollars when they had to pay the money (not at the time of opening these LC’s). As expected Bangladesh Bank intervened and stopped them from creating deferred LC’s. Now, while opening LC’s the banks had to buy dollars using BDT. So supply of BDT was automatically decreasing from the financial system. Now let us again look at some numbers for the period between July-Nov 2010.
Exports Receipts (BDT 57,925 crores), Import Payments (BDT 66,871 crores), Remittances (BDT 32,067 crores), Fresh Lc opening (BDT 87,472 crores)
The key number here is the fresh LC opening which is much greater than all the other figures. Moreover, when banks suddenly have to make payments for the deferred Lc’s a substantial amount of BDT has to go out of the system to buy dollars. Further proof of this hypothesis is evident since dollar is getting stronger against the BDT.
I agree with the view of the BB governor who believes that 160 mn people cannot suffer because of the greed of few stock market investors. With inflation inching up, the prudent step (debatable according to some people) by the central bank was probably tightening of the monetary policy. Then again, if that is the case then BB should probably stop saying that there is adequate liquidity. The truth is that the liquidity shortage still exists. Because of this if real sector investors are deprived of financing then the ultimate loser will be the country.
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