In a recent Asian Development Bank (ADB) working paper titled “Bangladesh’s Monetary Policy Transmission Mechanism,” the authors – In Huh and Yoonsoo Lee – found that traditional monetary policy tools used by the Bangladesh Bank (BB), such as repo rate and reserve currency (RM), do not work as expected.
However, the national savings certificate affects the economy in a way more akin to that of a monetary tool.
More specifically, a positive shock to the reserve currency should lower the interest rate. In practice, however, as the document notes, a positive shock (BB’s expansionary policy) leads to an increase in the interest rate.
In addition, increasing the repo rate (the rate at which banks borrow from the Bangladesh Bank) is an example of restrictive monetary policy because it reduces the money supply and allows the central bank to control inflation. under ideal circumstances. But the authors found that repo rate shocks did not have a significant impact on the broad money supply.
To explain these contradictory and counterintuitive results, the study argued that extremely high yielding National Savings Certificates (NSCs) crowded out private sector investment and may have distorted the relationship between monetary instruments and their goals. targeted.
The commercial standard spoke to Dr Saleh Uddin Ahmed, former governor of the Bangladesh Bank, to make sense of the rather puzzling findings of the AfDB’s discussion paper and sought advice for the next few days.
TBS: According to the ADB report, the monetary policies of the Bangladesh Bank are not having the desired effect. Is it true? Why is this happening?
Dr Saleh Uddin: This is not entirely wrong. First of all, you have to understand that there is always a gap between the implementation of monetary policies and their impact. Monetary policy changes such as adjusting interest rates, cash reserve ratio (CRR) or statutory liquidity ratio (SLR) may take longer than usual to show desired results.
More often than not, the Bangladesh Bank fails to meet the monetary policy objectives it has set for itself. Changing policy rates often does not significantly affect financial markets because they are not sufficiently sensitive to interest rates. This happens because the monetary reserve in Bangladesh only covers 40% of all financial transactions. This is why even a change in interest rates as large as 1-2% may not affect the economy in a way that BB predicted.
In addition, monetary policy is always less effective than fiscal policy. I have already argued that BB should stop focusing on policy rates and instead focus on the proper implementation of its regulations and the compliance of private financial institutions with these regulations. Unless private banks comply with the policies introduced by BB, the policies will never have the intended effect.
TBS: The ADB study also asserts that the growing dependence on National Savings Bonds distorts the effects of monetary instruments? Is it true? How to fix this problem ?
Dr Saleh Uddin: National savings certificates are high yielding because the interest rates on them are much higher than bank rates. But those who buy NSCs are usually not big investors. At best, they can buy NSCs worth 30 lakhs Tk. Large investors do not invest through NSCs.
So ideally, NSCs primarily serve as a government’s fiscal policy tool to provide some sort of safety net for the middle class, as well as the marginalized, instead of acting as an instrument for capital investment.
However, this does not mean that its impact on monetary policy is insignificant. But I think it is not enough to distort the effects of monetary policy. There is a more systemic problem at play here which involves corruption, mismanagement, and discretion.
TBS: The ADB study recommends that the development of a robust bond market would improve the market for loanable funds. How would you rate these recommendations?
Dr Saleh Uddin: The development of a bond market is, without a doubt, essential for a more responsible investment environment. Globally, most investments take place in the capital or bond markets. Banks usually have an upper exposure limit beyond which they cannot and should not grant loans to protect public money from undue exposure to risk.
But in the absence of a robust bond market and an underdeveloped stock market in Bangladesh, private banks are lending beyond their exposure limits, which has led to the crisis in which it finds itself. currently our financial sector.
In addition to developing a bond market, borrowing needs should be linked to stocks held in the form of bonds, especially in the case of large investments. That is to say, one cannot contract a certain amount of loans without having a threshold of own funds. At the same time, the Bangladesh Bank also needs to improve its auditory prowess and financial management of the banking sector. A robust bond market, along with a well-managed capital market, has the potential to establish accountability in the loanable funds market.
TBS: The ADB study also recommended that the Bangladesh Bank conduct a monetary policy focused on interest rates, instead of the typical supply-focused instruments. What would your recommendation be?
Dr Saleh Uddin: First, the Bangladesh Bank needs to ensure that the financial system as well as the money market is formalized. Most financial transactions currently take place informally. People take loans from local loan sharks, pawn shops, relatives or friends instead of going to the formal money market. This is why monetary instruments seem ineffective.
The introduction of instruments focused on interest rates would also have a similar result unless the vast majority of financial transactions take place in the formal money market. And to ensure this, the Bangladesh Bank must ensure financial inclusiveness to bring people into the formal money market. While mobile financial services have made strides in engaging marginalized rural communities, banks still have a long way to go.
TBS: What would be your general recommendation to the Bangladesh Bank to improve the effectiveness of its monetary policy?
Dr Saleh Uddin: In short, the Bangladesh Bank should not blindly follow conventional monetary policy instruments followed in the UK or the US. The Bangladesh Bank must first assess how its policy rates affect different sections of society differently. For example, how the same policy rates can affect large and small investors differently. Based on its assessment, it may set up mixed policy rates, such as different interest rates for investors with different levels of capital.
More importantly, it is high time for the central bank to end corruption and discretion. There is a discourse about “rules against discretion”. Unless you follow the rules, discretion becomes the norm and most financial transactions in Bangladesh are executed through discretion. Unless BB tackles these discretionary forces, no monetary instrument will be able to deliver the desired results.