How effective will the new monetary policy be?

Visual: Salman Sakib Shahryar

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Visual: Salman Sakib Shahryar

The Bangladesh Bank (BB) has unveiled its Monetary Policy Statement (MPS) for the period July to December 2022 at a difficult time. The global economy is under inflationary pressure that has not been felt in the recent past. Countries are struggling to weather the shocks caused by the Covid-19 pandemic and the ongoing Russian-Ukrainian war. In this context, BB announced its MPS with its usual three objectives: inflation control, job creation and gross domestic product (GDP) growth.

To achieve them, the MPS offers a list of areas in which the central bank wishes to intervene through policy actions. But the announced measures are not enough. While pursuing a tight monetary policy to contain inflation and reduce pressure on the exchange rate, BB also aims to support the process of economic recovery by assuring funds to productive sectors and employment-generating activities. Monetary policy will also promote import-substituting economic activities. To reduce exchange rate depreciation pressure, protect foreign exchange reserves and control inflation, the policy will discourage imports of luxury goods and many foreign goods.

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The projections of the main economic and monetary indicators are ambitious and largely neglect the realities. The MPS expects the inflation rate to be 5.6% in the 2022-23 financial year. This is optimistic against the backdrop of the current global economic trend and the outlook for 2023. International organizations such as the World Bank have predicted that several countries may face recession and stagflation in the coming days – as has was the case in the 1970s. If Bangladesh’s inflation is mostly imported, then how can it be expected to come down so quickly in a year as the global economy continues to struggle? According to the International Monetary Fund (IMF), in 2022, emerging and developing countries will face an inflation rate of 8.7%. The situation will improve in 2023, but these countries will still suffer from inflation of 6.5%. It can be noted that in May 2022, inflation in Bangladesh increased to 7.42%.

Moreover, according to the MPS, low inflation will be associated with strong economic growth in the country. Therefore, GDP growth is expected to be 7.5% – which was also mentioned in the draft national budget for the financial year 2022-23. Optimism was expressed considering factors such as the economic boost due to the recently inaugurated Padma Bridge. The bridge will surely strengthen economic activities and investments, which will lead to higher growth, but one year is too short to observe such a leap.

The MPS adopted “a cautious policy with a tightening bias to contain inflation and exchange rate pressures while supporting the economic recovery process.” However, some of the projections are not compatible with this objective. It projected credit growth to the private sector of 14.1% for FY 2022-23, which is higher than the 13.1% estimated for FY 2021-22. Of course, it was originally set at 14.8% for the 2021-22 fiscal year. Therefore, the projected growth of credit to the private sector is not lower than the estimated real growth of the previous year. Public sector credit growth is set at 36.3% in FY 2022-23, which is higher than 27.9% in FY 2021-22. Broad money growth is expected to reach 12.1% in FY 2022-23 from 9.1% in FY 2021-22 according to the MPS.

Given supply constraints, commodity prices have risen beyond consumer affordability. Ongoing inflation is occurring in a situation where economies are also experiencing low growth due to the pandemic. People have less money at their disposal. Therefore, developing policies to control this inflation is much more difficult than inflation due to a booming economy. However, many central banks around the world are currently pursuing a restrictive monetary policy to reduce the money supply, using tools such as interest rates and the buying and selling of government securities, so-called open market operations.

To put it simply, a higher rate of interest is adopted to reduce individual consumption. Households may feel encouraged to save and spend less because of attractive interest rates. On the other hand, since loans also become expensive due to higher interest payments, there will be a further reduction in consumption. This should reduce the money supply in the market. In open market operations, central banks sell securities to other banks, which puts upward pressure on interest rates and reduces the money supply in the market.

Using monetary policy tools, the Bangladesh Bank raised its policy rate – or repo rate – by 50 basis points, from 5 to 5.5%, to cope with pressure from Requirement. Repo is the short-term purchase of public securities by banks with the agreement to resell them within a specified period. The decision to raise the policy rate is a positive step as it is an important tool in determining the interest rate. However, an increase in the policy rate does not mean much, since the ceiling on the lending rate for banks remains at 9% and the weighted average nominal lending rate fell to 7.08% in May 2022.

With such central bank interventions, monetary policy tools become dysfunctional. Banks do not find it interesting to lend money. Conversely, companies also feel dissatisfied with banks due to rising credit rates. Therefore, interest rates should be determined by the market and adjusted automatically, depending on the demand for credit and the supply of funds. Interest rate deregulation will also help control imports and stabilize the foreign exchange reserve. The MPS mentions that BB will observe the lending cap issue and take policy action if necessary. Instead of such ad hoc decisions, it should adopt a modern monetary policy that allows for a flexible interest rate regime for reduced inflationary pressure and stable foreign exchange reserves.

Dr Fahmida Khatun is executive director of the Center for Policy Dialogue (CPD). The opinions expressed in this article are those of the author.

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