The Bangladesh Bank has made a policy decision to introduce an interest rate target-based monetary policy partially in the next monetary policy to be announced in June as per the suggestion of the International Monetary Fund (IMF).
With this interest rate target, the central bank will manage inflation following the monetary policy model that India follows, said a senior executive of the central bank.
A committee has been formed comprising a group of Bangladesh Bank officials who will visit India to gain hands-on experience from The Reserve Bank of India under the capacity development project of the IMF, he said.
The IMF has set the condition for the Bangladesh Bank to go for a flexible interest rate-based monetary policy as part of its $4.7 billion loan approved for the country in February.
At present, the Bangladesh Bank follows a money supply target-based monetary policy model which failed to tame inflation as the money supply is not the cause of the current price pressure but it has been fuelled by external factors and energy price adjustment.
Moreover, the lending rate cap kept loans cheaper, which made monetary policy dysfunctional, said industry insiders.
The Bangladesh Bank in its current monetary policy projects to manage inflation within 7.5% this fiscal year but the rate shot up to 8.78% in February after energy prices were hiked several times.
The Bangladesh Bank governor in an event at the Bangladesh Business Summit, organised by the Federation of Bangladesh Chambers of Commerce and Industry on 11-13 March this year, said that they were working to introduce an interest rate corridor very soon.
How the interest rate corridor will work
Interest rate-based monetary policy is a type of macroeconomic policy that is used by central banks to control the level of inflation and economic growth by influencing the interest rates in the economy.
In this policy, the central bank adjusts the interest rates on loans to banks, known as the "policy rate", which affects the interest rates that banks charge their customers for borrowing money.
The Bangladesh Bank will set a maximum and minimum limit for policy the rate which will be used as reference rates for the lending rate in the market. The central bank will set an interest rate target for the call money market and based on that target it will supply money to manage inflation, said the senior executive of the central bank.
At present, money supply tools do not impact inflation as the lending rate cap keeps money cheaper, he said, adding that if the lending rate cap is not lifted, the new policy will not work either.
So, the central bank is pursuing the government to lift the cap when the central bank enters into the new interest rate-based monetary policy model in June, he added.
The Bangladesh Bank in the existing monetary policy uses the repo rate to manage the impact of money supply on inflation. If the policy rate is increased money is supposed to become expensive, but that principle is not working now due to the lending rate cap, he said.