determinants of interest rates in bangladesh

8/12/2019 Determinants of Interest Rates in Bangladesh

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Table of Contents

Executive Summary.2

Introduction..2

Origin of the report...2

Objective of the report..2

Scopes and Limitations.3

ethodo!ogies...3

Interest rate and its determinants3"#

$na!ysis of regression e%uation.&"'

$na!ysis of corre!ation matrix'"(

)onc!usion........................(

*ib!iography.(

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Determinants of Interest Rates in Bangladesh

Executive Summary:Interest rate is app!icab!e on a!! type of !ending a!!over the ,or!d. Lending can be of different

types- but in this report ,e ,i!! be concerning about the determinants of interest rate oncommercia! !ending in *ang!adesh. Interest rates can be determined by many factors but here ,e

,i!! consider six factors as the determinants of interest rate. hese six factors are /ross 0omestic

1roduct /01- )onsumer 1rice Index )1I- *udget 0eficit- oney Supp!y- 4emittance and

5oreign 0irect Investment 50I. In this report ,e ,i!! try to find out ho, these factors affect the,eighted average rate of interest on commercia! !ending and the re!ationships bet,een each of

the factors and the interest rate. o find the effect of the factors on interest rate ,e ,i!! ana!y6e

the regression e%uation and to find the re!ationship ,e ,i!! ana!y6e the corre!ation matrix. 7e,i!! use statistica! soft,are ,hich is ca!!ed S1SS to produce the regression e%uation and

corre!ation matrix. o ma8e a proper report ,e need a !arge poo! of data and ,e decided to

co!!ect data from +9(+"+9(2 to 2::'"2::(. 7e co!!ected data from Economic rends pub!ishedby *ang!adesh *an8- Economic 4evie, pub!ished by 5inance inistry of *ang!adesh

/overnment- ,ebsite of *ang!adesh *an8 and ,ebsite of ministry of finance. *ut ,e ,ereunab!e to find a!! the necessary data from +9(+"+9(2 to 2::'"2::(- in some cases data are

missing- in some cases the data bases are different and many other prob!ems. 7e found that a!!the data are avai!ab!e from +99&"+99' to 2::'"2::(. So ,e ,i!! try to ana!y6e these data and

ma8e a proper report.

Introduction:his report is about the determinants of interest rate. $ny change in the interest rate is genera!!y

caused by these factors and the factors are /ross 0omestic 1roduct /01- )onsumer 1riceIndex )1I- *udget 0eficit- oney Supp!y- 4emittance and the 5oreign 0irect Investment

50I. $ny change in any of the determinant is responsib!e for the change in interest rate. ;ere

,e ,i!! try to find out ho, the determinants affect the interest rate and ,hat are their re!ations,ith the interest rate

o !earn about the determinants of interest rates in *ang!adesh.

o !earn ho, the determinants or factors affect the ,eighted average rate of interest on

commercia! !ending

o !earn about the re!ationships bet,een each of the factors and the ,eighted averagerate of interest on commercia! !ending.

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Scoes:In this report ,e tried to give a brief idea about the determinants of interest rates in *ang!adesh

but avai!abi!ity and the inconsistency of data is the main prob!em that ,e faced ,i!e ma8ing thisreport. 7e used S1SS to ana!y6e the data- so the report ,ou!d be more justified if ,e cou!d

co!!ect a!! the previous data.

"imitations:he !imitation of this report is the non avai!abi!ity of the data. 7e tried to co!!ect data from

+9(+"+9(2 to 2::'"2::( but in some cases data before +99&"+99' are not avai!ab!e. $notherprob!em is the inconsistency of data. In some cases it is found that- data are different for the

same year for the same factor. In those cases ,e have to avoid those data- as a resu!t the poo! of

data became sma!!er. here are some other !imitations. 5or examp!e- the ,ebsites of *ang!adesh*an8 and inistry of 5inance are not ,e!! organi6ed. *oth the ,ebsites have archives but they

don?t have data before 2::& in their ,ebsites.

#ethodologies:

o prepare this report ,e ,or8ed a!! ,ithin the group together. o co!!ect the data ,e used thesecondary sources. $s ,e needed the historica! data- ,e don?t have to use any primary source.

Our main sources of data are the Economic rends pub!ished bi *ang!adesh *an8 and theEconomic 4evie, pub!ished by inistry of 5inance.

Interest rate and its determinants:

Interest rates:Interest is app!icab!e to a!! 8inds of !oans. Every financia! institution- that is !ending money to thedeficit unit charges interest. Lending can be of different types- it can be agricu!tura! !ending- it

can be rea!"estate !ending- it can be consumer !ending or it can be commercia! !ending etc.

Interest is app!icab!e on a!! these types of !ending. ;ere ,e are concerned about on!y the interestrates on commercia! !ending in *ang!adesh. In *ang!adesh before +993 there ,as no financia!

institution. So the on!y source of commercia! !oans ,as the schedu!ed commercia! ban8s- but the

interest rates app!icab!e on these !oans ,ere fixed by the *ang!adesh *an8. In +993 some

financia! institutions started there operations. hey ,ere a!so permitted to give commercia! !oansbut interest rates ,ere fixed by the *ang!adesh *an8. i!! +99&"+99' interest rates on

commercia! !ending ,ere fixed by the centra! ban8. 5rom +99'"+99( a!! the commercia! ban8s

and financia! institutions ,ere permitted to fix the interest rates on commercia! !oans bythemse!ves. =o, they can fix their interest rates on commercia! !oans according to their needs.

5or ana!ysis ,e have co!!ected data about ,eighted average rate of interest on commercia!

!ending.

Determinants of Interest rates:$s it has been to!d ear!ier that there are many determinants of interest rates but ,e areconcerning about six factors or determinants- in this part ,e ,i!! high!ight those determinants.

he most important determinants of interest rates are>

/ross 0omestic 1roduct /01

)onsumer 1rice Index )1I

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*udget 0eficit

oney Supp!y

4emittance

5oreign 0irect Investment 50I

$ross Domestic %roduct &$D%':he gross domestic product /01 is a basic measure of a country@s overa!! economic output. It

is the mar8et va!ue of a!! fina! goods and services made ,ithin the borders of a country in a year.It is often positive!y corre!ated ,ith the standard of !iving- though its use as a stand"in for

measuring the standard of !iving has come under increasing criticism and many countries are

active!y exp!oring a!ternative measures to /01 for that purpose. /01 is an importantdeterminant of interest rates. If /01 increases- it means economy is in a good condition and in a

gro,th economy demand for money for investment increases rapid!y but the supp!y of money

does not increases in comparison to demand. $s a resu!t interest rate increases/01 can increase>

+. if price !eve! increases-

2. if %uantity of goods and services increases.

he opposite ,i!! happen if /01 decreases that means in an economic s!o,do,n.

Consumer %rice Index &C%I':

$ consumer price index )1I is a measure estimating the average price of consumer goods and

services purchased by househo!ds. $ consumer price index measures a price change for a

constant mar8et bas8et of goods and services from one period to the next ,ithin the same areacity- region- or nation. It is a price index determined by measuring the price of a standard group

of goods meant to represent the typica! mar8et bas8et of a typica! urban consumer. he percent

change in the )1I is a measure estimating inf!ation. )1I is direct!y re!ated to interest rate. If an

inf!ation is expected- savings of the househo!d decreases because the househo!ds ,ant topurchase the necessary goods and services before the increase of price !eve!. $s a resu!t supp!y

of money decreases. On the other hand businesses ,i!! demand more funds to imp!ement the

projects before the increase of price !eve!. So the increasing demand and decreasing supp!y ,i!!cause the interest rate to rise.

Budget Deficit:

*udget deficit is the amount by ,hich a government- company- or individua!@s spending exceeds

its income over a particu!ar period of time. It is a!so ca!!ed deficit or deficit spending. If there is a

deficit in the budget government demand for money increases but the supp!y remain constant./overnment ,i!! borro, money at any interest rate unti! the money is needed. So the increasing

demand for money increases the interest rates.

#oney Suly:

oney supp!y or money stoc8 is the tota! amount of money avai!ab!e in an economy at a

particu!ar point in time. here are severa! ,ays to define AmoneyA. oney is the set of assets that

peop!e regu!ar!y use to purchase goods and services from other peop!e. oney inc!udes cash-demand deposit- trave!ers chec8- saving deposit- sma!! time deposit 504 and money mar8et

mutua! funds. )ash- demand deposit and trave!ers chec8 a!! together are 8no,n as =arro,

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money + and the narro, money +- saving deposit- sma!! time deposit and money mar8et

mutua! funds together are 8no,n as *road money 2. 7hen centra! ban8 increases money

supp!y- the supp!y of !oanab!e fund increases but the demand remains constant. $s a resu!t-interest rate decreases. On the other hand if the centra! ban8 co!!ects money from economy-

supp!y of !oanab!e fund decreases. $s a resu!t- interest rate increases.

Remittance:

$ remittance is a transfer of money by a foreign ,or8er to his or her home country. oney sent

home by migrants constitutes the second !argest financia! inf!o, to many deve!oping countries-exceeding internationa! aid. 4emittances contribute to economic gro,th and to the !ive!ihoods of

needy peop!e ,or!d,ide. 4emittances a!so foster- in the receiving countries- a further economic

dependence on the g!oba! economy instead of bui!ding sustainab!e- !oca! economies. 4emittance

is an important factor ,hich has a great inf!uence in change of interest rates. If the tota!remittance sent by foreign ,or8ers increases- supp!y of !oanab!e fund ,i!! increase but the

demand ,i!! remain constant. his increasing supp!y of money ,i!! decrease the interest rate.

(oreign Direct Investment:5oreign direct investment 50I is a measure of foreign o,nership of productive assets- such as

factories- mines and !and. Increasing foreign investment can be used as one measure of gro,ingeconomic g!oba!i6ation. 50I is one of the most important determinants of interest rates in

*ang!adesh. If the 50I increases it ,i!! indicate a good economic condition. So the demand for

!oanab!e fund ,i!! increase for investment. Eventua!!y it ,i!! increase the rate of interest.

So far ,e have discussed the factors that affect interest rates. =o, ,e ,i!! see ho, much these

factors affect the interest rate by ana!y6ing the regression e%uation.

he data ,e have co!!ected are given be!o,>

in crore ta8a.Financialyear

Rate ofinterest

Economic condition(GDP)

Inflation(CPI)

Budgetdeficit

Moneysupply Remittance FDI

1!"1# 1$%!& 1'#1 1$%! "$! !*#% !$%+ !'%$*

1#"1' 1*%!& *1## 11*%! "+* '!%1 !$+%! 11$1%

1'"1 1$%& *1! 1*%+ "# !$*#%1 '1#%#' 1%

1"* 1$%$& *$#'! 1*+%$1 "1#+ #+#!*%+ '#%$ 1*!%'#

*"*1 1*%!*& *$+! 1*!%#* "1$+ '#1#+%* 11#%1 *!#%'

*1"** 1$%*& *#$*1 1$%*! "111 '!1! 1+$##%$ **+%1

**"*$ 1*%*+& $' 1$%# "11+ 11$+% 1##*'%'1 *1##%+

*$"*+ 11%1!& $$*#$ 1+$% "11$ 1*#*1%* 1'!%' 1!*!%#+

*+"* 1%*& $### 1$%*+ "1$# 11++!% *$!+!%# +11%*

*"*! 11%!& +1#*' 1!+%*1 "1$#1 1'!#+%* $**#+%!$ +*#%*!"*# 1*%*!& +#*+## 1#!%+ "1*1 *11+%$ +1*'%+ +#+%'

*#"*' 1*%!$& +'** 1$%+ "*+!+ *+'#+% +*%1+ ++

CExcept Interest rate and )1I a!! the data are in crore t8.

CInterest rates are in DC)1I base year is +99#"+99&.

C0ata on budget deficit ,ere given in S do!!ar. o convert it into t8. 7e used the period

average exchange rate of the re!evant year.

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)nalysis of Regression E*uation:

S1SS statistica! system generated the output sho,n be!o,>Coefficients (a)

Model

,nstandardi-edCoefficients

.tandardi-edCoefficients

t .ig%B .td% Error Beta

1 (Constant) 1#!!%$ !!%$$ *%!$ %+!

Economiccondition(GDP)

"%1* %1 "1$%#! "1%** %*'$

Inflation (CPI) 11%* 1%#* $%1 %!' %1!

Budget deficit "%1 % "%'' "1%1$* %$

Moneysupply (M*)

%! %1* +%11$ %$ %!1

Remittance %$ %' %+1 +%1# %

ForeignDirectIn/estment(FDI)

%' %* %1+1 %$1+ %#!!

a% Dependent 0ariale2 Interest rate

he genera! from of a mu!tip!e regression e%uation is

Y= a + b1X1 +b2X2 + b3X3 + + bkXk

;ere-

)oefficient for constant- a = +'&&.:39)oefficient of /01 b1= ":.:+2

)oefficient of )1I-b2 = ++.::2)oefficient of *udget 0eficit- b3= ":.:+:)oefficient of oney Supp!y 2- b4= :.::&

)oefficient of 4emittance- b5 F :.:3#

)oefficient of 50I-b6F :.::(

So the determined regression e%uation is>

Y interest rate+ ,-../012 30/0,4X15,,/004X26 0/0,0X35 0/00.X4 50/017X55 0/008X6

Discussions:

+. +'&&.:39 a is the point through ,hich regression !ine crosses or

intercepts the G"axis.

2. ":.:+2 b+ means if /01 increases by + unit- Interest rate ,i!! bedecreased by :.:+2D ho!dingX2, X3, X4 ,X5 andX6 constant.

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3. ++.::2 b2 means if )1I increases by + unit- Interest rate ,i!! be

increased by ++.::2D ho!dingX1,X3, X4,X5 , and X6 constant.

B. ":.:+: b3 means if *udget 0eficit increases by + unit- Interest rate ,i!!

be decreased by :.:+:D ho!dingX1, X2,X4,X5 and X6 constant

#. :.::& bB means if oney Supp!y increases by + unit- Interest rate ,i!!

be increased by :.::&D ho!dingX1, X2,X3,X5 and X6 constant

&. :.:3# b# means if 4emittance increases by + unit- Interest rate ,i!! be

increased by :.:3#D ho!dingX1, X2,X3,X4 and X6 constant

'. :.::( b& means if 50I increases by + unit- Interest rate ,i!! beincreased by :.::(D ho!dingX1, X2,X3,X4 and X5 constant

In the next part ,e ,i!! see ho, the determinants are corre!ated to interest rates by ana!y6ing thecorre!ation matrix.

)nalysis of Correlation matrix:

S1SS statistica! system generated the output sho,n be!o,>

Correlation #atrix:Correlations

Interest

rate

Economic

condition (GDP)

Inflation(CPI)

Budgetdeficit

Moneysupply(M*)

Remitance

ForeignDirect

In/estment(FDI)

Interest rate PearsonCorrelation

1 "%11 %* "%$ % %$1 %!11(3)

Economiccondition(GDP)

PearsonCorrelation "%11 1 %#(33) "%$+(33) %(33) %''(33) %'!$(33)

Inflation (CPI) PearsonCorrelation

%* %#(33) 1 "%+*(33) %+(33) %'1(33) %'#*(33)

Budget deficit PearsonCorrelation

"%$ "%$+(33) "%+*(33) 1 "%*(33) "%*$(33) "%#1(33)

Money supply(M*)

PearsonCorrelation

% %(33) %+(33) "%*(33) 1 %''(33) %'!(33)

Remitance Pearson

Correlation

%$1 %''(33) %'1(33) "%*$(33) %''(33) 1 %'(33)

Foreign DirectIn/estment(FDI)

PearsonCorrelation %!11 %'!$(33) %'#*(33) "%#1(33) %'!(33) %'(33) 1

3 Correlation is significant at t4e % le/el (*"tailed)%33 Correlation is significant at t4e %1 le/el (*"tailed)%

Discussions:

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a /01 has a moderate negative ":.#++ corre!ation ,ith interest rate.b )1I has a moderate positive :.#2: corre!ation ,ith interest rate.

c *udget deficit has a ,ea8 negative ":.399 corre!ation ,ith interest rate.

d oney supp!y has a moderate positive :.#:9 corre!ation ,ith interest rate.

e 4emittance has a ,ea8 positive :.39+ corre!ation ,ith interest rate.f 50I has a strong positive :.&++ corre!ation ,ith se!!ing price.

Conclusion:

$t the very !ast ,e ,ant to say Interest inc!udes many considerations. It can be determined bymany factors- but ,e have considered the most important factors that are most!y responsib!e for

any change in the interest rate. $!! the determinants ,e mentioned and ana!y6ed have significant

impact on the interest rate and it is proven by the ana!ysis. his report ,ou!d be more accurateand justified- if ,e cou!d co!!ect a!! the historica! data regarding to the determinants but the data

are not avai!ab!e. So ,e have tried our best ,ith the avai!ab!e data.

Bibliograhy:

+. Economic rends- Statistics 0epartment- *ang!adesh *an8 $ugust 2::9H 1age +3- 3(-B#- B&- '#- '9 J 9+.

2. *ang!adesh Economic 4evie, 2:::- Economic $dviser@s 7ing- 5inance 0ivision-inistry of 5inanceH 1age +'2- $ppendix K B#.

3. *ang!adesh Economic 4evie, 2::(- Economic $dviser@s 7ing- 5inance 0ivision-inistry of 5inanceH 1age 239- $ppendix K +.+ J 1age 292- $ppendix K ##.

B. *ang!adesh *an8 7ebsite> ,,,.bang!adesh"ban8.

#. inistry of 5inance 7ebsite> ,,,.mof.gov.bd

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determinants of interest rates in bangladesh

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