Why inflation taming measures fail in Bangladesh

Policy rate matters. It dictates lending rates in the financial market. Central banks worldwide use this tool to tighten flow of money into the economy and tame inflation. And it works; inflation has declined in the USA and the UK from their decades' peak.

But it does not work in Bangladesh the way it is intended. It makes borrowing costlier but does not tame inflation.

In October last year, the Bangladesh Bank hiked its policy rate by a high margin not seen in decades. Earlier in July, it introduced a reference rate based on six-month average treasury bill rate plus 3%. It resulted in average lending rate of banks surging to 13.55% in March, by more than 4% in nine months since the central bank scrapped lending rate cap in June last year.

Businesses got an instant hit. Their borrowing costs soared, credit growth slowed, production slumped.

But there is no relief for consumers. Inflation remained close to 10% in March as it was in June last year.

Inflation would stay high

In a meeting with central bankers on Wednesday, a visiting team of the International Monetary Fund (IMF) noted that the central bank's rate formula did not help inflation decline as expected.

Earlier this month, the global lender, in its World Economic Outlook, said inflation in Bangladesh would stay high, above 9%, though it projected a steady decline in global inflation. It also lowered the economic growth forecast for Bangladesh to 5.7% for the current FY24.

Similar projections came from the World Bank which warned Bangladesh's economy would remain stressed with slower growth and high inflation, weighing on private consumption growth, shortages of energy and inputs, rising interest rates, and financial sector vulnerabilities dampening investor sentiment.

These are the same factors businesses in Bangladesh cite to explain how the costs of their business soared, cutting their profit margin and competitiveness. A number of industrialists last week told The Business Standard about their struggle to stay afloat. They said prolonged high inflation squeezed people's consumption, causing a decline in production. Again, lower production impacts the supply to the market, adding further to the price pressure. 

High cost of business related to BB policies

Three of the reasons cited for escalating cost of business – weakening taka, import restrictions, and rising interest rates – are directly related to the central bank's policy measures. All those measures have raised the cost of both locally-produced and imported goods, contributing further to inflation.

The Bangladesh Bank restricted imports to save dollars. It depreciated taka massively to incentivise remittance and export proceeds to bring home more dollars. But foreign exchange reserve is still short of the level set to access the next tranche of the IMF's $4.7 billion loan package.

Even after massive depreciation, dollar rates widely vary between banks and the kerb market. Costlier and hard-to-get dollars raised the cost of raw materials for industries and essential food items, raising prices of everything people buy.

The Bangladesh Bank itself acknowledged that weakening of the Taka has been "a contributing factor" to domestic inflation, as the cost of imports has risen.

Repeated hikes in the policy rates brought down inflation in the USA to 3.5% and in the UK to 3.2% in March from their historic peaks. Investors in both the countries are worried about further hikes in key rates as inflation still remains above the targets of their central banks.

US Federal Reserve chief Jerome Powell has already said inflation is taking longer-than-expected time to fall and still remaining higher than its target of 2%. It gives a hint that the rate hike regime has not ended in the USA. 

But it is hard to find any such link between the policy rate and inflation in Bangladesh.

In its latest monetary policy statement in January, Bangladesh Bank raised its policy rate further to 8%. Four months later, inflation remains much higher than its existing target.

Devalued taka didn't help export growth

In its latest policy statement for January-June 2024, it announced its plan for a gradual shift towards a market-based exchange rate system to stabilise the exchange rate and prevent further depletion of the country's foreign exchange reserve. It agreed to implement a crawling peg system, advocated by economists to check unusual fluctuations in the currency's value.

This has not happened yet, and exchange rate volatility continues. Central bankers told the IMF team last week that they were still examining the crawling peg system.

Taka weakened massively against the dollar in the last one and a half years. It should have benefited exporters and remitters. But the boost has not been as big as expected.

The dollar rate, which was Tk86 before the Russia-Ukraine war, is now Tk111 officially and it might be Tk120 in the kerb market. An exporter now gets at least Tk25 more as value of one dollar worth of export than one and a half years before.

"We have had a currency depreciation of around 30%, which should have raised our export competitiveness much higher. It was the exporters' persistent demand for currency depreciation and it has now happened because of economic realities. Even then export growth remains only 4-5%," economist Prof Mustafizur Rahman of the Centre for Policy Dialogue (CPD) tells The Business Standard.

The same policy that yields intended results in other countries fails here or sometimes works contrarily. It is because of institutional weakness that limits gains from other advantages, Prof Mustafizur points out. "If we cannot enhance our labour productivity, our capital productivity to improve competitiveness in other areas, if our cost of business remains high, then even 30-35% currency depreciation may not be enough to cover our other weaknesses."

This may explain why the central bank's policy rate hike, though leading to substantial rise in borrowing cost, has not helped check inflation. As default loans mounted causing a liquidity crisis in the banking sector, the central bank had to print money in the previous fiscal year to meet the government's borrowing needs and feed the cash-strapped banks. This created an additional inflationary pressure.

The measures taken so far by the central bank have neither stabilised the exchange market, nor eased inflation. Rather those fuelled inflation further.

Yet, the central bank believes average general inflation will align with the government's revised 7.5% target by June FY24. The IMF projects will stay above 9.3% this fiscal before starting to moderate in FY25. Let's see what happens.