The central bank of Bangladesh, Bangladesh Bank (BB), has recently announced the Monetary Policy Statement (MPS) for FY 2023 which drew special attention due to the circumstances under which it was declared.
Many other economies including Bangladesh are experiencing surging inflation simultaneously being pulled by demand and pushed by cost. Apart from the computational debate on inflation estimates, the official inflation estimates hit 5.99% in May crossing the annual targeted threshold of 5.33%.
Cost-push inflationary pressure arises from the Russia-Ukrainian war which shook the supply chains worldwide predominantly from increased energy prices. The recent floods in the north and north-eastern regions of the country will also add to this pressure.
Moreover, after the Covid-19 pandemic, as economies start getting back to the pre-covid states, substantial import demand, one of the major causes of demand-pull inflation, increased which the authority responded by taking measures aiming at discouraging imports of luxurious goods.
The MPS23 decides to increase the Letter of Credit (LC) margin for luxury goods, fruits, non-cereal items, and canned and processed foods to utilise the remittance more prudently. It is to be noted that Bangladesh could pay on an average three months import bill with the flow of remittances (import cover) even in 2011, according to the World Bank.
Compared to that situation, Bangladesh had a minimum of 5.26 months of import cover in march 2022. So, we should not panic unnecessarily about the current lower import cover because this situation is at a much better place than the 2009-2013 fiscal year's averages.
However, the tightening measures in terms of spending remittances, with the backdrop of the bankruptcy of Sri Lanka and near Pakistan, are appropriately justified but concerns remain to achieve the goals.
The existing worldwide inflationary surge appears to be the major challenge even to the Feds, which acknowledged its inability to control the factors that could tame inflation.
Yet, it increased the interest rates as a measure of 'preemptive strike' in response to unbridled price distortion which may impair the long-term goal of lower stable inflation and optimum employment. It does so because anchoring inflation expectations in many instances prove to be a key to signalling market confidence.
The tightening monetary policy aims at preventing the weakening of the Taka against the dollar and bringing unbridled inflation under its grip, but it poses another threat of harming the new employment creation by discouraging entrepreneurs from launching new adventures.
In this connection, it is well remembered that decreasing the policy rates in an attempt to boost economic activities failed to decrease the interest rates across countries during the 2009 global recession due to the increased perceived risk of bankruptcy feared by the banks. The post-Keynesian economists believe this to be the key reason for the failure to avert 2009's global recession.
But the current reverse case of increasing the policy rate in Bangladesh will be immediately translated to the interest rates, which is believed to be downward sticky in a competitive environment.
However, in Bangladesh, we follow the managed 6-9% interest rates. This entails some additional implications for the contractionary monetary policy. For the increased policy rates, private banks are now required to pay more as interest to the BB which is intended to lower inflation.
Since banks will now pay more money to buy dollars and get loans from the BB, it must entail an upward pressure on the lending interest rate which is now capped at a 9% rate. So, it is high time to revoke the ceiling of 9% lending interest rates.
Otherwise, it will crowd out funds for private sectors immensely, given that the Bangladesh government will borrow Tk1,063 billion from the banking channel. Moreover, the BB has committed to ensuring the required flow of funds to the priority and productive sectors to promote supply-side activities; a self-contradiction in the light of mechanisms stated above.
Besides, the same argument applies to a new refinance line of credit for import-substituting products aimed at reducing import dependency and saving precious foreign reserves.
First of all, enough funds may not be sourced to finance import-substituting products and even if funds are managed to finance, any large-scale financing given the context will result in more inflation.
In the present-day macro world, the effective monetary policy must allow exchange rates and interest rate flexibility, not the pegged one. Because of the capped lending rate, the monetary policy may prove to be futile to lower the inflation rate.
It accentuates the urge to leave the exchange rate to the market and withdraw the lending cap from the rigid 9% level, meaning creating more room for market mechanisms to play in action in these markets.
Otherwise, the goal of taming inflation through merely increasing repo rates, and raising LC rates from 75% to 100% for some items might not be sufficient enough in the looming global recessionary context.
Moreover, the real effective exchange rate of the Taka is kept overvalued artificially against the dollar through obligatory declared rates instead of letting the market perform independently. It creates a huge demand for foreign exchanges in the market which the formal channel will fail to supply.
Consequently, Taka will keep losing its value in the kerb market creating a congenial atmosphere for the Hundi business which will reduce the inflow of remittances, the golden deer that the central bank wants to earn more.
Merely a 2.5% incentive on remittance earnings is not sufficient enough to encourage remittance inflow into the country. Instead, some reformative actions must be taken including the ease and frequency with which remittances can be sent to Bangladesh.
For example, the banking channels take a longer time to receive money sent from abroad than mobile financial services which receive money in less than one hour of the transaction. However, the remittance recipients have to bear a significant cost for converting the remittance money into cash or depositing it into bank accounts.
The Bangladesh Bank must come forward to stop or at least reduce this withdrawal charge for remittance earnings. Alone this attempt can reduce the psychological costs of the remitter to send money to Bangladesh, and will prove to be more effective in attracting remittances in the current dire situation.
The MPS committed to policies of supporting the Import substituting industries, but these industries cannot be built overnight. The policy support for the import-substituting industries should be targeted for the mid-term plan which may sound more coherent then.
Only the monetary policy can never be effective in lowering inflation, rather a concerted effort of fiscal and monetary policy may prove to be fruitful. But from the perspective of the monetary policy, the new governor must take decisions on revoking the lending rates cap, at least it should be allowed to hit the pre-pandemic level rates and allow the flexibility of the exchange rates. These crucial decisions will determine the directions and sustainability of the macroeconomic indicators of Bangladesh.
Maruf Ahmed is a Research Fellow at the Bangladesh Institute of Development Studies and a second-year PhD student in Economics at the University of Technology Sydney. The author can be reached at: [email protected]
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.