Can 25 basis-point hike in policy rate tame inflation?

The Bangladesh Bank has raised the policy rate for the third time in four months by 25 basis points to 5.75%, aiming to tighten money flow and thus check inflation amid rising credit growth.

The hike in the key interest rate, also known as repurchase agreement rate, at which banks borrow from the Bangladesh Bank, will make money costlier, discouraging banks to lend.

The new rate will come into effect from 2 October, according to a circular issued by Bangladesh Bank on Thursday.

The policy rate is a monetary tool, which is used to dampen credit demand, but the credit growth had remained upward even after policy rate hikes in the previous couple of occasions owing to the lending rate cap. 

The policy rate became ineffective when lending rate was fixed at 9% as banks could not make money costlier for borrowers. 

The Bangladesh Bank raised the policy rate from 4.75% to 5% in May when the private sector credit growth was nearly 13%. Later in the monetary policy for the current fiscal year, the central bank hiked the rate for the second time in June to 5.50% when credit growth was 13.66%. 

Finally, the credit growth crossed 14% in August which is very close to the monetary target of 14.1% set for the current fiscal year, prompting the Bangladesh Bank to further raise the rate. 

The Bangladesh Bank raised the policy rate at a time when global central banks are also tightening monetary policy to guard inflation. 

The Reserve Bank of India may raise interest rates by another 50 basis points this month after data showed that inflation rose further above the central bank's tolerance limit in August, according to media reports. 

Central bank chief economist Md Habibur Rahman told The Business Standard that the repo rate has been raised mainly because of concerns over a rise in inflation. Banks now will borrow comparatively low from the central bank.

Asked about any possible impact on the call money rate because of the policy rate hike, he said, "We want banks to borrow from one another at lower than the repo rate."

Replying to another question, the central bank chief economist said they do not yet know about how much impact the repo rate hike will have on taming inflation.

Overall, inflation dropped by 0.08 percentage points in July after five months of sharp increases. Food inflation stood at 8.19%, registering a drop of 0.18 percentage points from June.

However, the government did not release inflation data for August even after a month.

Zahid Hussain, former chief economist at the World Bank's Dhaka office, told TBS that it is nothing but a symbolic step. Usually, if the policy rate is raised, so is the lending rate. The lending rate rise leads to a fall in credit demand. Thus, demand for goods and services fall, causing inflation to cool off.  

"This theory will not be effective in our country because of the lending rate cap," he said.

The economist thinks the call money rate may increase owing to the repo rate hike.

Asked about the measures that the central bank can take to rein in inflation, Zahid Hussain said ideally, removing the lending rate cap can be a solution. Or, setting a flexible rate without going for a specific rate can be an alternative solution.

Depreciation of taka could further stoke inflation: Central bank 

The significant depreciation of the taka against the dollar amid soaring inflation could intensify the price pressure putting adverse effects on the country's economy, the Bangladesh Bank has said. 

"Compounding adverse effects of elevated global commodity and energy prices, recent upward adjustment of petroleum and fertiliser prices in the domestic market, and a significant depreciation of the taka against the dollar could intensify the cost-push shocks to the economy," it made the observation in its quarterly report for April-June released recently.

The Bangladesh Bank devalued the taka against the greenback by 12% in less than nine months. It sold dollars at the rate of Tk85.80 in the beginning of 2022, which is now Tk96. Meanwhile, the Association of Bankers, Bangladesh and the Bangladesh Foreign Exchange Dealers Association, with the mediation of the central bank, have set the rate of a dollar at Tk99 for export encashment, and Tk107.5 for import bill payment. 

"With a broadening current account deficit, the exchange rate in terms of taka against US dollar has been sharply depreciating since the beginning of FY22 in line with the market requirement," the report said.

The Bangladesh Bank projects a further rise in inflation – which fell 0.08 percentage points to 7.48% in July after five months of sharp increase – due mainly to price hikes of fuel and fertiliser.

"The sharp rise in input prices – fuel and fertilisers – could lead to a reduction in food production which in turn will weigh on food quality and availability," the Bangladesh Bank report said.

"Although much will depend on unfavourable weather conditions during the Aman cultivation period, downward nudge of the world food and non-energy prices in June 2022 will likely influence the domestic food market in coming months." 

The central bank also projected that the current account deficit, which has been widening amid the foreign exchange crisis, could worsen further in the coming months due to a slowdown in remittance inflows and a surge in import expenditure.

"With a continuous fall in remittance inflows together with import surge, current account deficit is likely to widen in the near term," the Bangladesh Bank said.

"A further escalation of the Russia – Ukraine war could pose downside risk through intensifying the global supply shocks which might, in turn, hamper the trade situation."

With increased imports, Bangladesh registered a record trade deficit of $33.25 billion in FY22, according to the central bank data. At the same time, the deficit in the current account balance of foreign transactions also exceeded $18.5 billion.

The trade deficit, however, has been narrowing over the first two months of the current fiscal year in comparison with the same period of the previous fiscal year, thanks to a drop in imports amid the various measures by the central bank, and a rise in remittance influx. 

The Bangladesh Bank also sees risks for the banking sector amid rising inflation and external sector volatility. "The recent surge in inflation coupled with external sector volatility originated from the Russia-Ukraine war may pose greater challenges to the banking industry," it said.

"Moreover, rising non-performing loans along with lower deposit growth may put further pressure in coming days."