IMF suggests interest rate targeting monetary policy to tame inflation 

Illustration: TBS

The International Monetary Fund (IMF) has suggested that Bangladesh Bank should go for a flexible interest rate targeting-based monetary policy shifting from its monetary targeting framework as the existing model becomes dysfunctional to check inflation with only money supply target when external factors affect the country's economy.

The visiting IMF mission came up with the suggestion at a meeting held recently with the monetary policy department of the Bangladesh Bank as part of a discussion over the terms and conditions of a prospective $4.5 billion loan sought by the Bangladesh government. 

The central bank agreed to transform its monetary policy framework gradually by the year 2026, according to a meeting source. 

He said the lending rate cap has to be lifted to implement the new monetary policy framework and Bangladesh Bank agreed with the IMF in this regard.

The IMF will provide technical assistance to develop the institutional capacity of the Bangladesh Bank to modernise the monetary policy framework, said a senior executive of the central bank who attended the meeting. 

With this new framework, the Bangladesh Bank will target the interest rate of the call money market to manage liquidity and check inflation. 

Currently, the central bank sets a ceiling for credit growth, broad money and reserve money growth to achieve targeted Gross Domestic Product (GDP) growth and inflation. 

In the latest monetary policy for the current fiscal year, the Bangladesh Bank has set domestic credit growth at 18.2%, broad money growth at 12.1% and reserve money at 9% to achieve a 7.2% GDP growth. 

This monetary ceiling, however, became ineffective to check inflation when the government hiked fuel prices amid the global energy crisis. 

In August, domestic credit growth was 16.59%, broad money growth 8.31% and reserve money growth was 4.75%. 

Though there is still ample room for the Bangladesh Bank to supply money in the market, inflation has already crossed 9% since August fueled by global factors, surpassing the target of 5.30%.

As a result, the Bangladesh Bank could not use its monetary tools to check the inflation now. 

On the other hand, if the targeted money ceiling is not fulfilled, expected GDP growth will not be achieved. This is the weakness of the monetary targeting framework, according to a central bank official. 

This is how Bangladesh Bank's monetary policy failed to manage liquidity keeping inflation and achieving expected GDP growth as well.  

In this context, the IMF suggested the central bank to come out from outdated monetary targeting framework as advanced economies shifted from this framework in between the 70-80s. 

All advanced economies, even India, follow inflation targeting monetary policy framework which is more sophisticated. 

India introduced this inflation targeting monetary policy in the year 2014.

Inflation targeting monetary policy requires a more sophisticated economy as the central bank will have to be fully empowered to use its monetary tools and the financial market will have to be more advanced with a matured bond market to manage liquidity, said a senior officer of the central bank. 

However, the IMF suggested Bangladesh Bank to go for interest rate targeting policy as the financial market is not capable enough to adopt the inflation targeting policy, he said. 

How the interest rate targeting monetary policy framework will work: 

A senior officer of the monetary policy department of the Bangladesh Bank explained that in this framework, call money rate will be targeted. For example, inter-bank call money is very sensitive, because it reflects the liquidity situation and strength of commercial banks. 

At present, the call money rate is volatile. As the central bank is more focused on managing the monetary ceiling instead of keeping the call money rate stable.

With this new framework, Bangladesh bank will keep the call money rate stable. For instance, when banks will go for aggressive lending putting pressure on inflation, the central bank will raise the call money rate to give a signal to be cautious. 

When the call money rate will rise, borrowing overnight or inter-bank will be costlier for banks prompting them to slow down credit disbursement. 

How monetary targeting monetary policy failed to check inflation: 

The Federal Reserve bank kept raising interest rates to check inflation and finally it started to work as high borrowing cost affected consumers.

Following global central banks, the Bangladesh Bank also raised the policy rate several times, but it failed to tame inflation and depress credit demand due to the lending rate cap. 

In September, the Bangladesh Bank raised the policy rate for the third time in four months to 5.75%, aiming to tighten money flow and thus check inflation amid rising credit growth.

The policy rate is a monetary tool, which is used to dampen credit demand, but the credit growth had remained upward even after policy rate hikes in the previous couple of occasions owing to the lending rate cap.

The policy rate became ineffective when lending rate was fixed at 9% as banks could not make money costlier for borrowers. 

The Bangladesh Bank raised the policy rate from 4.75% to 5% in May when the private sector credit growth was nearly 13%. Later in the monetary policy for the current fiscal year, the central bank hiked the rate for the second time in June to 5.50% when credit growth was 13.66%. 

Finally, the credit growth crossed 14% in August which is very close to the monetary target of 14.1% set for the current fiscal year, prompting the Bangladesh Bank to further raise the rate.

Moreover, Bangladesh bank needs to tighten money supply to check inflation. But monetary ceilings are still far below from the target set in the monetary policy.