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Can monetary policy limit inflationary hike?

Published : Sunday, 18 August, 2024 at 12:00 AM  Count : 178
AKM Asaduzzaman Patwary
For the first half of FY 2024-25, Bangladesh Bank has proposed a cautiously tight monetary policy stance in July 2024. The monetary policy usually aims at controlling inflation and rational fund and liquidity management. Currently,the economy is undergoing various economic challenges including foreign exchange reserve volatility, incremental cost of doing business induced low trade and investment above all inflationhas become the pressing challenge that holds back the desired and inclusive economic growth and stability. 

The recently declared MPS of Bangladesh bank for H1 of FY2025 has kept the policy rate unchanged including the policy (repo) rate at 8.50%. Standing Deposit Facility (SDF) at 7%, and Standing Lending Facility (SLF) at 10%. Keeping these rates unchanged, the central bank seeks to hold back the inflation hike and stabilize the money supply state. Apparently, these strategies help to moderately lower the inflationary pressure by reducing the money supply and discouraging excessive spending and borrowing, thus contributing to price stability. In fact, inflation not only provokes the living standard but also affects the cost of doing business and investment.

The MPS has set new public and private sector credit growthnew targets. The public sector credit growth target significantly reduced to 14.2% for July-December FY2025, down from 27.8% in the second half of FY2024. Conversely, the private sector credit growth target has been realised at 9.8% lower than the target and projects 9.8% in the H1. By reducing public sector borrowing, the central bank aims to decrease the government's bank borrowing. However, maintaining steady credit flow to the private sector is crucial for sustaining private sector trade and economic growth without exacerbating inflation. Furthermore, the MPS introduces a market-driven reference lending rate replacing the previous lending rate cap. This shift is expected to promote and cultivate a favourable lending climatewithin the banking sector. The volatile economic state induced by political unrest may challenge this expectation and implementation.

To support this lower public borrowing target, a well-managed fiscal policy plays a crucial role and the excessive borrowing to meet the deficit national budget may bar this public sector borrowing target. Alongside, stable exchange rate is vital tool to stabilize our balance of trade and economic competitiveness. The import is staggeringly low due to weak reserve and relentless decline of BDT against USD. The low trend of import also affects the export growth too. Therefore, the foreign exchange reserve and stable exchange rate have gained huge importance in the economy now.

Prioritising the stable exchange rate and reserve, the MPS emphasises strengthening the crawling peg system. As far as we know, the crawling peg is an interim approach but this has been applied in Nicaragua and Argentia but it failed there as Argentina experienced hyperinflation. Crawling peg requires economic condition assessment and analysis with all trading economics which cannot be a feasible technique for us.By allowing the BDT exchange rate to depreciate in line with the Real Effective Exchange Rate (REER) Index, Bangladesh Bank aims to enhance export competitiveness while managing import costs. 

This measure is expected to help balance of payment and inflation control by stabilizing the currency. Additionally, the policy suggests innovative approaches to increase foreign reserve and manage government borrowing more effectively, ensuring that borrowed funds are directed towards productive investments but the innovative approaches are nonexistent. The establishment of a policy interest rate corridor and adoption of a revised approach to calculate gross foreign reserve aligning with international guidelines have not enabled to stabilize the foreign exchange rate. The curb market rate and central bank determined exchange rate are different which inflate the cost of trade and business.It is also important to find the right amount of reserve to map and plan our economic course of actions further including foreign trade and local industrial operations.

Moreover, the Net Foreign Assets (NFA) projection of 17.8% in FY25is apparently a positive step. In the given state of the economy, the credit rating of the country is recorded low and stagnant at B + at long-term marked by S&P and Moody's which may not secure higher foreign asset in Bangladesh. While the repo rate remains unchanged at 8.50%, other market control measures are necessary to tame inflation. It is worth mentioning that the policy or fed rate lead the inflation in US economy and exposure of lending is often affected due to policy rate which is unusual in Bangladesh. The personal credit has a small share of total lending portfolio. Appropriate and supportive fiscal policyis crucial. Bangladesh Bank may adopt flexible monetary policy adjusting the policy interest rate, and closely monitor their impacts on inflation and economic growth. The new MPS will have to accommodate the need for higher government borrowing from commercial banks. With a liquidity crunch in banking sector, the government relied on borrowing from the central bank in 2023 and printing currency, and this possibility exists in FY2024 as well in the given context, which will further fuel inflationary pressure amidst the low local fiscal revenue collection. The given economic situation may require more austerity and other administrative measures from different organs of the economy. Strong coordination between fiscal and monetary policies is essential to stabilize the financial sector. Improved risk management practices and stronger oversight are needed, and Bangladesh Bank can actively provide re/pre-financing schemes to key growth sectors such as manufacturing, agriculture, and CMSMEs through tailored credit facilities to stimulate local economic activities.

The strategies outlined in the MPS are primarily focused on containing inflation through a combination of tight monetary policy, careful management of credit growth, and exchange rate stabilization. By maintaining higher interest rates and reducing public sector borrowing, the central bank aims to limit the money supply and demand-pull inflation but this conventional strategy is unlikely to perform in inflation management as experiencedin the MPS in the earlier years. Traditionally, our consumer market, base and financial sectors are very unstructured and scattered where the conventional techniques hardly bring in positive changes.

We believe making MPS and circulation of it is not enough rather regular market trend monitoring, monthly market guidance and financing trend oversight are needed. In the USA, the Federal Reserve System has a Federal Open Market Committee (FOMC) which regularly follows the lending and credit management trend in the economy and guides to make the MPS successful to large extent. The emphasis on improving foreign reserve and stabilizing the exchange rate is expected to mitigate cost push inflation by controlling the cost of imports. 

Bangladesh Bank has to work with other core agencies like TCB, Ministry of Commerce. Many other policy decisions from relevant ministries like Agriculturethrough uniform price of essential food items, smooth supply chain management actors like transportation and Logistics with a fixed and common transport tariff and fiancé ministry, NBR can collectively act to hold back the inflationary trend alongside policy guidance under MPS. In addition, effective solutions are to be mentioned to cut the non-food inflation factors and items especially energy supply and price management.

Import dependence of fuel and gas and austerity in power production cost may be useful revisiting the PPA and Speedy Supply of Power and Energy (Special Provision) Act 2010.The latest national inflation has been recorded 11.66% highest ever in the last 14 years which needs attention. Bangladesh can follow the precedent of Bank of England like routine weekly meeting to monitor money flow in the market. Furthermore, the central bank's proactive measures, such as the Prompt Corrective Action framework for weak banks to reduce non-performing loans, are likely to improve fiscal flow and financial stability, thereby contributing to inflation control. These comprehensive strategies, when effectively implemented, are expected to help achieve the inflation target of 6.5% and support consistent economic growth in Bangladesh though the prevailing law and order and economic unrest may not ease this target. 

However, addressing the inherent challenges requires a multifaceted approach involving prudent flexible monetary policy, external economic and non-economic factors, effective fiscal management,structural reforms above all positive mindset of all business stakeholders for the economic intereststo stabilize the financial sector and ensure rigorous market monitoringto cut the inflationary hikefor ensuring affordable cost of living and business conditions.

The writer is an Execuitve Secretary(R&D), DCCI


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