Monetary policy statement 2023: will it curb inflation?

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Bangladesh is under inflationary pressure. Recently Declared Monetary Policy Statement (MPS) May Not Sufficiently Address Crisis

July 23, 2022, 1:30 p.m.

Last modification: July 23, 2022, 4:00 PM

Illustration: TBS

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Illustration: TBS

Bangladesh’s central bank, Bangladesh Bank (BB), recently announced the monetary policy statement (MPS) for the financial year 2023, which attracted particular attention due to the circumstances under which it was declared.

Many other economies, including Bangladesh, are experiencing runaway inflation, driven by both demand and costs. Apart from the IT debate over inflation estimates, official inflation estimates hit 5.99% in May, breaking through the target annual threshold of 5.33%.

Inflationary pressure from the cost push stems from the Russian-Ukrainian war which has rattled global supply chains primarily due to rising energy prices. The recent floods in the northern and northeastern parts of the country will also add to this pressure.

Moreover, after the Covid-19 pandemic, as economies begin to return to pre-covid states, substantial import demand, one of the main causes of demand-driven inflation, has increased, which to which the authority responded by taking measures to discourage imports of luxury goods. goods.

The MPS23 decides to increase the Letter of Credit (LC) margin for luxury goods, fruits, non-grain items, and canned and processed foods to use funds more prudently. It should be noted that Bangladesh could pay an average of three months of import bill with the flow of remittances (import coverage) even in 2011, according to the World Bank.

Compared to this situation, Bangladesh had a minimum of 5.26 months of import cover in March 2022. So there is no need to panic unnecessarily about the current decline in import cover as this situation is at a much better place than the averages for the 2009-2013 fiscal year.

However, the tightening measures in terms of remittance spending, against the backdrop of the bankruptcy of Sri Lanka and nearby Pakistan, are duly justified but concerns remain about meeting the targets.

The current global inflationary spurt appears to be the major challenge even for the Fed, which has acknowledged its inability to control the factors that might keep inflation in check.

Yet he raised interest rates as a “preemptive strike” measure in response to rampant price distortion that may harm the long-term goal of lower stable inflation and optimal employment. . It does this because anchoring inflation expectations in many cases turns out to be a key element in signaling market confidence.

The tightening monetary policy aims to prevent the weakening of the taka against the dollar and bring unbridled inflation under its sway, but it poses another threat of undermining new job creation by discouraging entrepreneurs from embarking on new ventures. adventures.

In this regard, it is well recalled that the lowering of policy rates with the aim of stimulating economic activities failed to lower interest rates in all countries during the global recession of 2009 due to the increase in the perceived risk of bankruptcy feared by banks. Post-Keynesian economists believe this is the main reason for the failure to avert the global recession of 2009.

But the current reverse case of an increase in the policy rate in Bangladesh will immediately affect interest rates, which are thought to be lower in a competitive environment.

However, in Bangladesh, we follow managed interest rates of 6-9%. This has additional implications for tight monetary policy. For the increase in key rates, private banks are now required to pay more interest to the BB, which aims to reduce inflation.

Since banks will now pay more money to buy dollars and obtain loans from the BB, this must put upward pressure on the loan interest rate which is now capped at 9%. It is therefore high time to repeal the 9% cap on interest rates on loans.

Otherwise, it will hugely crowd out funds for the private sector, as the government of Bangladesh will borrow 1,063 billion taka from the banking channel. In addition, the BB is committed to ensuring the required flow of funds to priority and productive sectors to promote supply-side activities; a self-contradiction in light of the mechanisms set out above.

Moreover, the same argument applies to a new refinancing line of credit for import substitution products aimed at reducing dependence on imports and saving precious foreign exchange reserves.

First, there may not be sufficient funds to finance import substitution products and even if the funds are managed to fund, any large-scale financing, given the context, will result in more of inflation.

In today’s macro world, an effective monetary policy must allow flexibility in exchange rates and interest rates, not indexation. Due to the capped lending rate, monetary policy may prove futile in bringing down the rate of inflation.

This heightens the urge to leave the exchange rate to the market and remove the lending cap from the hard 9% level, which means creating more room for market mechanisms to operate in these markets.

Otherwise, the goal of controlling inflation by simply raising repo rates and raising LC rates from 75% to 100% for certain items may not be enough in the face of a looming global recession.

Additionally, the real effective exchange rate of the Taka is kept artificially overvalued against the dollar through declared mandatory rates instead of letting the market operate independently. This creates a huge demand for currencies in the market that the formal channel will fail to supply.

Therefore, Taka will continue to lose value in the parallel market, creating a pleasant atmosphere for Hundi business, which will reduce the influx of remittances, the golden deer that the central bank wants to earn more.

A mere 2.5% incentive on remittance earnings is not enough to encourage remittances in the country. Instead, some reforming actions need to be taken, including the ease and frequency with which remittances can be sent to Bangladesh.

For example, banking channels take longer to receive money sent from abroad than mobile financial services which receive money within an hour of the transaction. However, recipients of remittances face a significant cost to convert the remittance into cash or deposit it in bank accounts.

The Bangladesh Bank must come forward to stop or at least reduce these withdrawal fees for remittance income. This attempt alone can reduce the sender’s psychological costs of sending money to Bangladesh and will prove more effective in attracting remittances in the current dire situation.

The MPS is committed to supporting import substitution industries, but these industries cannot be built overnight. Policy support for import substitution industries should be targeted for the medium term plan, which then may seem more coherent.

Monetary policy alone can never be effective in bringing down inflation; on the contrary, a concerted effort by fiscal and monetary policies can prove fruitful. But from a monetary policy perspective, the new governor needs to make decisions on revoking the lending rate cap, at least he should be allowed to reach pre-pandemic level rates and allow exchange rate flexibility. . These crucial decisions will determine the direction and sustainability of Bangladesh’s macroeconomic indicators.


Maruf Ahmed, Research Fellow, Bangladesh Institute of Development Studies. Illustration: TBS

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Maruf Ahmed, Research Fellow, Bangladesh Institute of Development Studies.  Illustration: TBS

Maruf Ahmed, Research Fellow, Bangladesh Institute of Development Studies. Illustration: TBS

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