The Bangladesh Bank has tightened money flow by raising its policy rate as taming inflation has been given a top priority in the new monetary policy for the fiscal 2022-23, making a departure from its ultra-loose monetary policy taken in the last two years.
The central bank raised the policy rate, which is also known as the repo rate, by 50 basis points to 5.50% from 5% – a record hike in recent history – in the new monetary policy announced on Thursday.
This is the second time the central bank raised the policy rate in the span of a month. Earlier, on 29 May this year, the central bank increased the repo rate from 4.75% to 5% after almost two years.
In July 2020, the central bank reduced the policy rate by 50 basis points from 5.25% to 4.75% to ease money flow amid the pandemic crisis.
The surge in the rate will make money expensive for banks as they borrow money from the Bangladesh Bank on the repo (repurchase agreement).
"We have taken a cautious policy stance with a tightening bias to contain inflation and exchange rate pressure," said Bangladesh Bank Governor Fazle Kabir while announcing the new monetary policy at a press conference at its headquarters.
He said checking inflation and keeping foreign exchange reserves stable is the number one priority to the central bank.
"The main challenge of the monetary policy will be to tame inflation and keep the exchange rate stable in FY23," said the governor.
In this context, the central bank hiked policy rate, walking the path of other central banks in developed and developing countries, such as the United States, the United Kingdom, Europe and even India, where the policy rate was raised by taking a contractionary monetary policy stance, he said.
The country's inflation hit an eight-year high of 7.42% in May.
Zahid Hussain, former lead economist at the World Bank's Dhaka office, said only a policy rate increase cannot tame inflation.
Lending rate has to be increased to rein in inflation.
Syed Mahbubur Rahman, managing director and chief executive officer of Mutual Trust Bank Limited, told The Business Standard, "It is conflicting that the central bank has raised the policy rate but has not done the same to lending rates of banks."
If banks now are to pay 6.5% in interest on deposits, it will be difficult for them to lend at 9% by maintaining statutory liquidity ratio (SLR) and cash reserve ratio (CRR), he noted.
"I think lending rates should have been raised by 2-3%," he also said.
He further said it is good that the central bank has imposed a higher LC margin on imports of various non-essential commodities to keep the forex reserves stable. "I think some imports should be stopped completely," he added.
Under the current tight money market condition with the increased costs of funds amid higher inflationary and exchange rate pressures, keeping the lending rate cap fixed at 9% might pose a challenge in the near future as it will narrow down the interest rate spread to some extent, said the monetary statement.
However, with the rapid development of financial technology, the improved efficiency of banking operations would contribute to scaling down the banks' operating costs, it noted.
Addressing the fixed lending rate, Dr Md Habibur Rahman, chief economist of Bangladesh Bank, said banks made good profit even at the fixed lending rate.
So, the fixed lending rate amid tight liquidity will not create pressure for banks, he noted.
The weighted average lending rates for all banks stood at 7.08 % in May, meaning that the 9% lending cap still has enough space for usual lending activities, stated the monetary policy.
The central bank will remain watchful of this lending cap issue and take policy actions, if necessary, said the statement.
As part of tightening money flow, the private sector credit growth ceiling was cut to 14.1% for FY23 from 14.8% of just the outgoing fiscal year. The actual private sector credit growth in June was 13.1%, according to the monetary policy statement.
The credit flow to the private sector was squeezed to support the government to meet its bank borrowing target of Tk1.06 lakh crore set in the new budget.
The public sector credit growth ceiling was set at 36.3% for FY23, up from the 32.6% target of FY22. The actual credit growth in the public sector was 27.9% as of June, according to the policy statement.
Based on the public and private sector credit expansion, the domestic credit growth is set at 18.2% in FY23.
The Bangladesh Bank will ensure the quality and quantity of credit for productive economic activities to achieve the targeted 7.5% GDP growth, according to the new monetary policy.
The tight monetary policy has been announced at the time when the banking sector is already in tight liquidity amid falling deposits that pushed up money rates.
Surging inflation has caused savers to suffer a big loss, eating up Tk50,000 crore in savings from banks in the first 10 months of FY22.
The sharp fall in bank savings has dried up liquidity in the banking system at a time when the government and the private sector need money the most for investments.
When deposit growth is falling, credit growth keeps rising, putting pressure on liquidity, eventually leading to a sharp decline in excess liquidity.
The total excess liquidity dropped by Tk13,300 crore in the span of a month in April from Tk1.99 lakh crore in March, according to data from the Bangladesh Bank.
The tight liquidity has pushed up rates of call money and treasury bills, bonds and others.
The call money rate, which remained below 3% even at the beginning of this year, crossed the 5% mark in March and has kept rising as banks are borrowing money at call amid shortage of liquidity.
The yield rate of government treasury bills and bonds shot up to 8%-10% in June, which was below 4% several months ago. These rates have increased at a time when banks do not have enough liquidity to invest in government bills and bonds.
In the new monetary policy, the Bangladesh Bank projected negative foreign asset growth amid high import growth, which will keep the balance of position in deficit.
In this perspective, the monetary policy seeks to promote import-substitution economic activities and discourage imports of luxury goods, fruits, no-cereal foods, canned and processed foods to reduce exchange rate depreciating pressure, protect foreign exchange reserves and control inflation.
In this perspective, the central bank will introduce a new refinancing line of credit for import-substituting products to maintain import dependency and save valuable foreign exchange reserves.
The LC margin for luxury goods will be increased comprehensively to discourage their imports, according to the monetary statement.
The monetary policy projects 12% import growth in the new fiscal year when export growth will be 13% and remittance will grow at 15%. The forex reserve will reach $42.5 billion in FY23.
At present, foreign exchange reserves stand at $41.8 billion.
The foreign exchange rate volatility put pressure on foreign exchange reserves, forcing the Bangladesh Bank to devalue taka against the dollar in recent months.
At present, the interbank exchange rate is Tk 93.45 per dollar, which was Tk 84.81 in June 2021.
What governor says about his 6 years of experience with Bangladesh Bank
Sharing his experience, after announcing the last monetary policy of his tenure with the Bangladesh Bank, he said, "I came in a challenging time. I remember I was invited to a program of the undergrads of the London School of Economics last November. Someone asked me – are you enjoying your job as the governor of the central bank. I replied saying, actually I am not enjoying right now, but I'm counting on enjoying once my tenure is over. I'm hoping to start enjoying my time from next Sunday.
Speaking on qualifications to become a governor, he said, "I am the 11th governor, who came from bureaucrats. My successor is also a bureaucrat. There was one governor, who rose through the ranks in the central bank – the second governor AKM Ahmed. Two came from commercial banks – ANM Hamidullah and Lutfur Rahman. One governor was macroeconomist Atiur Rahman. The rest came from this track."
He went on to say, "In my opinion, coming from the bureaucrats has some extra advantages. A bureaucrat comes with experience from many roles. When bureaucracy is in my favour – the chief economist wing, research wing, statistics wing – I think a governor's life is easy. Even if the governor is not an economist himself, there will not be any problem. A governor can remain a bureaucrat and help with his diverse experiences at the field level, secretariat and in law formulation. Such diversity is rather helpful. The government will appoint a governor as the regulations dictate. The next governor is very knowledgeable and experienced."