Bangladesh Bank Training Academy Journal

Abstract

Theoretically, an increase in interest rate differentials—the difference between domestic interest rate and foreign interest rate—boosts either inflow of foreign loans or investment or both in any country. In Bangladesh, before the financial sector reform programme (FSRP) in 1990s, the inflow of external resources in the form of foreign direct investment (FDI), portfolio investment and other foreign loans were insignificant. But the policy changes in the financial sector, as well as the external sector, facilitated the increased inflow of external resources. Against this backdrop, this paper attempts to analyse empirically the relationship between foreign loan inflows and interest rate differentials in Bangladesh. The empirical results show that interest rate differentials have a positive impact on the gross inflows of foreign loans. It indicates that gross inflows of foreign loans will rise by 0.06 percentage point if interest differentials increases by 1 percentage point. However, the paper also finds that for the periods from quarters of 2012 onwards a higher response of gross inflows of foreign loans is evident with the change in foreign exchange policy. The paper suggests that liberalisation of external economic policies can expedite inflows of foreign loans in Bangladesh.