Market-based interest rate soon, governor signals

The interest rate will move to a fully market-based system "very shortly", Bangladesh Bank Governor Abdur Rouf Talukder has signalled – apparently in line with the IMF prescription over a $4.7 billion loan package.

"I think we are very close to a market-based interest rate. We are expecting that very shortly we will be moving to a fully market-based interest rate," he said at a programme yesterday.

"So, there will be no more restrictions on the interest rate. Banks will be at liberty to fix the interest rate based on supply and demand," the governor said during a session titled "Fiscal and monetary policies in the evolving economic order" on the first day of a two-day conference on "1st Development Studies International Conference Dhaka 2024."

Abdur Rouf's comment comes at a time when a review mission of the International Monetary Fund has been visiting Bangladesh. The mission is engaging with the Bangladesh Bank, the finance ministry, the National Board of Revenue, and various government officials to understand the reforms that the country has made and plans to execute.

Implementing a market-based interest rate, adopting a crawling peg system for the exchange rate, and maintaining foreign exchange reserves at a certain level are the topmost conditions to receive the third instalment of the loan.

Former central bank governor Atiur Rahman chaired and moderated the session. Former governors Salehuddin Ahmed and Fazle Kabir, along with former finance secretaries Mohammad Tareque and Mohammad Muslim Chowdhury, served as panel speakers.

"We are also following zero devolvement. That means the central bank is not buying the government Treasury bond or bill at all. We are now following a reference rate called SMART (Six-Month Moving Average Rate of Treasury Bill) plus margin because it was capped at 9% and 6% a few years ago," Governor Abdur Rouf Talukder said.

Commenting on the introduction of the crawling peg for the exchange rate, he said, "We are currently reviewing the exchange rate and working to introduce a crawling peg, which will be an arrangement before we transition fully to a market-based system."

The governor said the external balance of the country is performing well, with exports consistently increasing.

"We reduced imports because we had to preserve our foreign reserves. So we had to control imports, especially non-essential and less important imports. The current account has been positive for the last four or five months, but our financial account is still in the negative region," he added.

"For the last few months, especially February-April, although our financial account has been negative, with the surplus of the current account, our BOP is actually positive. We are experiencing less pressure, and we expect the financial account to be positive by the end of the year, which is our target."

The governor stated that currently, the country faces two major issues: inflation and reserve erosion.

"In terms of inflation, we have implemented various measures. Not only are we focusing on controlling demand, we are also concerned about supply-side interventions. Especially for SMEs and agriculture loans, both the government and the central bank are providing interventions to keep the supply side active in our economy," he added.

"If you deduct the interest payment, which is the primary deficit, it is only 2.6%. So, our fiscal deficit is not that high. However, I think next fiscal year it will be further tightened to 2.4% to 2.5%. Since we have a high cost of borrowing from the domestic side, our interest payment account is increasing every year. But I believe the fiscal deficit is well under control. A fiscal deficit of 2.5% of GDP is manageable," he continued.

"However, there is no reason why we should not increase our tax-to-GDP ratio. Currently, when we look at the combination, one-third is only direct tax and two-thirds are indirect tax. This means that the poor people are actually paying more tax than the rich people."

Referring to the numerous negative aspects of reducing imports, former governor Salehuddin Ahmed said, "By reducing imports, the government's tax revenue decreases. At the same time, private investment also drops."

Blaming the government's failure behind high inflation, the economist said a study on 40 countries showed that contractionary monetary policy has the biggest impact on the poor people of a country.

"It can't hurt the rich too much. So, the economic growth of the country should not be stopped to control inflation," he added.

Commenting on the various pressures facing the Bangladesh Bank, he said it is challenging for the central bank to extricate itself from bureaucratic or political influence.

"It is not possible to completely escape political influence, but the central bank governor must show more assertiveness in dealing with them. The central bank should strive to achieve autonomy. Now is the time for the central bank to take a stronger stance," he added.

Former governor Fazle Kabir said the budget size of the current fiscal year is Tk1 lakh crore larger than the previous fiscal year. However, he expressed support for the central bank's decision to maintain a contractionary monetary policy.

He said that while there may be temporary pain associated with contractionary monetary policy, it will yield fruitful results in the future.

Explaining the issue, Abdur Rouf Talukder said, "I think we need to consider the budget not just by the absolute number but also as a percentage of GDP. So, if you consider it as a percentage of GDP, it is actually smaller than last year's size in this year's budget and also in the revised budget. I think more than 13%, or 14%, has been cut in the revised budget. So it is now more contractionary than initially it was."

Former finance secretary Mohammad Tareque said, "The financial deepening (M2/GDP) is less than 40% in our country, while the percentage is larger in many of our neighbouring countries. The percentage is higher even in countries with economies of similar size to ours."

Abdur Rouf Talukder commented, "The financial deepening is around 39%. So, how can we deepen it further? There are two ways: increasing the net foreign asset or increasing the domestic asset. However, increasing the net foreign asset for now is challenging, but increasing the domestic asset again has an inflationary impact."

He further said countries with economies similar to Bangladesh, such as Thailand, Vietnam, and Cambodia, have financial deepening almost equivalent to 100% of their GDP, while Malaysia and Singapore have 150%. India's financial deepening is around 80% of its GDP.

"So, we are lagging behind in this area, and I think we have a lot of work to do regarding the fiscal deficit," he continued.

Former finance secretary Mohammad Muslim Chowdhury said Tk20,000 crore bonds are issued for power and fertilisers, which has increased the money supply in the market by about Tk1 lakh crore. "We need to take this into account because it is not compatible with contractionary monetary policy," he added.

Speaking on the issue, Abdur Rouf Talukder said that when the central bank supplies money to the economy through adjustments in its balance sheet or by buying government bonds, the money supply increases.

He clarified that it is not necessarily true that the money supply will increase solely by issuing bonds.

Citing an example, he said the central bank lent around Tk2 lakh crore to banks in the fiscal 2022-23, resulting in an increase in money supply of only Tk50,000 crore.