Fight against inflation, forex crisis: is the hike in the key rate the next tool for BB?

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Central banks around the world have started raising policy rates to contain inflationary pressure stemming from the ongoing global supply chain disruption and demand recovery.

Bangladesh has also not been spared from the rise in prices, which has also been driven by rising commodity prices.

In addition, the taka is facing depreciation pressure against the US dollar as the Bangladesh Bank has taken measures to contain the surge in import payments amid an acute shortage of US greenback in the market. local.

The Daily Star spoke to four economists about whether the BB should revise its policy rate, the rate at which a central bank lends money to banks in the short term.

Among them, three economists suggested the BB to raise the benchmark rate immediately and the others advised the central bank to monitor the situation before making any changes.

The policy rate, called repurchase agreement in Bangladesh, is a central benchmark interest rate, which is followed by commercial banks to set interest rates on loans and deposits.

An increase in the policy rate means a higher cost of funds for banks when borrowing from the central bank. It also drives up the interest rate on the loans.

Central banks usually consider raising the policy rate when they plan to reduce the supply of money to the market in times of high inflation.

In Bangladesh, the central bank last raised the policy rate on January 5, 2012, raising it by 50 basis points to 7.75%. The rate has come down over the years.

The central bank cut the key rate three times in 2020 to implement its unconventional monetary policy, which helped businesses borrow from banks more cheaply.

In July 2020, the BB cut the rate by 50 basis points to 4.75%.

Ahsan H Mansur, executive director of the Bangladesh Policy Research Institute, urged the central bank to raise the policy rate immediately.

He also suggested the central bank to depreciate the local currency against the dollar based on supply and demand.

The former International Monetary Fund economist argued that the taka would become more attractive if the BB devalued it while raising the policy rate.

He explained that exporters might not be interested in bringing back export earnings unless they get the desired exchange rate for the dollar.

In addition, removing the ceiling from the interest rate on deposits would encourage savers, both individuals and businesses, to park their funds with banks.

“Companies could launder money offshore to get a higher return, as many central banks raised their policy rates, which subsequently drove up lending rates,” Mansur said.

The central banks of the United States, United Kingdom and India raised their key rates during the first week of May to curb inflation. The European Central Bank is expected to raise the rate in July, for the first time in more than a decade.

Mansur said consumption and investment should be curbed to help Bangladesh relieve itself from the current currency crisis.

Foreign sources, which lend funds to governments and companies, are now keeping tabs on Bangladesh. If the steady flow of foreign currency encounters an obstacle, they will be reluctant to donate funds.

“In such a situation, the country will see the deepening of the crisis,” Mansur said.

Monzur Hossain, research director of the Bangladesh Institute of Development Studies, wonders why the central bank does not use monetary tools to contain inflation.

He recommended that the BB increase the key rate.

Inflation soared to 6.29% in April, the highest in 18 months, according to data from the Bangladesh Bureau of Statistics.

Hossain also called for the removal of the lending cap to reduce the money supply. An increase in the loan rate will also discourage imports.

A huge increase in imports put foreign exchange reserves under pressure and made the foreign exchange market volatile. This forced the central bank to devalue the taka six times this year.

The deposit rate cap, which is set based on the rate of inflation, must also be removed in order to attract deposits from the public, according to Hossain.

Zahid Hussain, a former senior economist at the World Bank’s Dhaka office, also backed the idea of ​​raising the policy rate and making the lending rate flexible.

“If the lending rate cannot be made flexible, there will always be room for the policy rate to rise.”

“Even if such a decision does not bring visible differences, it creates psychological value in the case of controlling inflation. The reduction in the key rate even continues to discourage banks from granting loans to individuals, even if demand is low.

Salehuddin Ahmed, former central bank governor, thinks the rise in inflation is largely not the result of demand; rather, it was driven by supply constraints.

“Thus, the central bank should take more time before making a decision on the policy rate.”

Ahmed, however, suggested removing the loan cap.

Md Habibur Rahman, the central bank’s chief economist, says money supply in the market has already tightened.

“Thus, the central bank has no intention of raising the policy rate at this time.”

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