Cenbank to enter interest rate-based monetary policy regime

The Bangladesh Bank is going to enter a new monetary policy regime by introducing an interest rate-targeting monetary policy framework aimed at enhancing the effectiveness of policy measures in managing inflation.

The new monetary policy for the first six months of the forthcoming fiscal 2023-24 will be announced today with significant changes coming in the lending rate, policy rate, reserve calculations, and exchange rate mechanism, according to a reliable source within the central bank.

The International Monetary Fund (IMF) recommended that the Bangladesh Bank adopt a flexible interest rate-targeting-based monetary policy, transitioning from its existing monetary targeting framework. The current model, focused solely on money supply targets, has proven inadequate in curbing inflation amidst external factors. 

An IMF mission proposed this change during their visit to Bangladesh in November last while discussing the terms and conditions of a prospective $4.5 billion loan requested by the Bangladesh government.

Presently, the Bangladesh Bank follows a monetary policy model based on money supply targets, which has failed to rein in inflation as the money supply is not the cause of the current price pressure but it has been fuelled by external factors and energy price adjustment.

Moreover, the lending rate cap kept loans cheaper, which made monetary policy dysfunctional, said industry insiders.

Despite the Bangladesh Bank's aim to manage inflation within 7.5% for the current fiscal year, the rate surged to a decade-high of 9.94% in May due to rising fuel prices in the global market and multiple price adjustments in the local market. 

Additionally, the private sector credit growth ceiling was set at 14.1% for FY23 in the current monetary policy to achieve the government's growth target. However, the actual growth rate remained significantly below the target, with May's private sector credit growth at 11.28%, according to central bank data.

The announcement of the new monetary policy comes at a time when most of the objectives of the current policy have not been achieved, and the overall economy is facing significant challenges, as evidenced by Moody's downgrade of both the banking sector and the country's credit rating.

Under the new monetary policy, the Bangladesh Bank will eliminate the lending rate cap and introduce a new lending rate formula based on a reference rate plus a risk premium. A new formula for setting the policy rate, also known as the repo rate, will also be introduced. 

There will also be an interest rate corridor, defining a maximum and minimum rate, as per the central bank source.

In an effort to adopt a market-based exchange rate, the Bangladesh Bank will revise the reserve selling rate in the new monetary policy. Currently, there are four exchange rates, including dollar rates for exports, imports, remittances, and reserves.

The new monetary policy will also include the announcement of foreign exchange reserves based on the Balance of Payments and International Investment Position Manual (BPM6) recommended by the IMF. The IMF set the floor on net reserves at $24.46 billion for June when the lender will conduct the first review of the performance criteria of the central bank.

The net reserves will be calculated according to the new formula prescribed by the IMF, and applying this formula would result in a net reserve of over $19 billion for Bangladesh, as per central bank data. This net reserve will be readily available for foreign exchange market interventions.

As of 7 June 2023, the Bangladesh Bank holds gross reserves totaling $29.77 billion. However, the IMF does not accept this figure, as certain components must be excluded from the gross reserves. 

Based on the IMF formula, which aligns with the BPM6 manual, the Bangladesh Bank will need to exclude foreign currency loans to local banks (Export Development Fund), deposits with state-owned local banks, deposits with the IDB Group, fixed-income securities below investment grade, a loan to Sri Lanka, and other foreign currency assets in non-convertible currencies.

Furthermore, the IMF says the central bank must also exclude the reserve-related liabilities to estimate the net reserves. Bangladesh's current reserve-related liabilities amount to $4 billion. By excluding this amount, the net reserve will be over $19 billion if this amount is excluded.

The IMF introduced the BPM6 manual in reporting the reserve and balance of payment in 2012 under its Safeguards Assessments agreement, which applies to all members of the Fund.

Introduced in 2000, the Safeguards Assessments are diagnostic reviews covering five key areas of control and governance within central banks, including the external audit mechanism, legal structure and autonomy, the financial reporting framework, the internal audit mechanism, and the internal controls system.

The IMF conducts its Safeguards Assessments mission every 12 years, as the policy's main objective is to mitigate the risks of resource misuse and data misreport.

Following the launch of BPM6 in 2012, the Bangladesh Bank adopted it for the balance of payment reporting but ignored the latest manual for reserve calculation. At that time, Atiur Rahman was the governor.