‘Unless BB controls discretionary forces, no monetary policy will bring intended results’

In a recently published working paper by the Asian Development Bank (ADB) titled "Monetary Policy Transmission Mechanism of Bangladesh," the authors – In Huh and Yoonsoo Lee – found that the traditional tools of monetary policy used by Bangladesh Bank (BB), such as the repo rate and reserve money (RM), do not perform as predicted. 

However, the national savings certificate affects the economy in a way more similar to that of a monetary tool. 

More precisely, a positive shock to reserve money should decrease the interest rate. In practice, however, as the paper finds, a positive shock (expansionary policy by BB) leads to an increase in the interest rate. 

In addition, increasing the repo rate (the rate at which banks borrow from Bangladesh Bank) is an example of contractionary monetary policy as it reduces the money supply and allows the central bank to control inflation under ideal circumstances. But the authors found that shocks to the repo rate had no significant impact on the broad money supply. 

To explain such contradictory and counterintuitive findings, the study argued that the extremely high-yield National Savings Certificates (NSC) were crowding out investment in the private sector and may have distorted the relationship between the monetary instruments and their intended targets.

The Business Standard spoke to Dr Saleh Uddin Ahmed, former Governor of Bangladesh Bank, to make sense of the rather perplexing findings of the ADB working paper and sought counsel for the coming days. 

TBS: According to the ADB report, the monetary policies by Bangladesh Bank are not having the intended effect. How true is this? Why is this happening?

Dr Saleh Uddin: It is not entirely untrue. Firstly, you have to understand that there is always a lag between the introduction of monetary policies and its impact. Monetary policy changes like adjusting the interest rates, the Cash Reserve Ratio (CRR) or the Statutory Liquidity Ratio (SLR) may take more time than usual to exhibit desired results. 

More often than not, Bangladesh Bank fails to achieve the monetary policy milestones it sets for itself. Changing the policy rates often do not affect the financial markets significantly as they are not sufficiently sensitive to interest rates. This happens because the broad money reserve in Bangladesh encompasses only 40% of all financial dealings. This is why even a change in interest rates, as large as 1-2% may not affect the economy in a manner intended by BB. 

On top of that, monetary policy is always less effective than fiscal policy. I once argued that BB should stop focusing on policy rates and should rather focus on the proper implementation of its regulations and the compliance of the private financial institutions to these regulations. Unless the private banks comply with the policies introduced by BB, the policies will never have the intended effect.

TBS: The ADB study also claims that the increasing dependence on National Savings Certificates is distorting the effects of monetary instruments? Is this true? How to address this problem?

Dr Saleh Uddin: National Savings Certificates are high-yield as the interest rates on them are much higher than the bank rates. But those who buy NSCs are not generally large investors. At best, they can purchase Tk30 lakh worth of NSCs. Large investors do not invest through NSCs. 

So ideally, NSCs serve mainly as a fiscal policy tool of the government to provide some sort of safety net to the middle-class, as well as, the marginalised, as opposed to acting as an instrument for capital investment. 

However, that is not to say that its impact on monetary policy is insignificant. But I believe it is not enough to distort the effects of the monetary policy. There is a more systemic problem at play here which involves corruption, mismanagement and discretionary powers.

TBS: The ADB study recommends developing a robust bond market would improve the market for loanable funds. How would you rate these recommendations?

Dr Saleh Uddin: Developing a bond market is, undoubtedly, essential for a more accountable environment for investment. Globally, most investments take place through either the capital market or the bond markets. Banks generally have an upper exposure limit beyond which they cannot and should not provide loans to protect public money from undue exposure to risks. 

But in the absence of a robust bond market and an underdeveloped stock market in Bangladesh, private banks provide loans beyond their exposure limits which led to the crisis our financial sector is currently in. 

On top of developing a bond market, the borrowing requirements should be tied to equity held in the form of bonds, particularly in case of large investments. That is, one cannot take out a certain amount of loans without holding a threshold level of equity. Simultaneously, Bangladesh Bank has to improve its auditory prowess and financial management of the banking sector as well. A robust bond market, as well as, a well-managed capital market has the potential to establish accountability in the market for loanable funds.

TBS: The ADB study also recommended that Bangladesh Bank should pursue an interest-rate centric monetary policy, instead of the typical supply-centric instruments. What would be your recommendation?

Dr Saleh Uddin: First, Bangladesh Bank needs to ensure that the financial system, as well as, the money market is formalised. Most financial transactions currently take place informally. People take out loans from local loan sharks, money lenders, relatives or friends instead of going to the formal money market. This is why monetary instruments appear to be ineffective. 

Introducing interest-rate centric instruments would also have a similar outcome unless the vast majority of financial transactions take place in the formal money market. And to ensure that, Bangladesh Bank must ensure financial inclusivity to bring the people to the formal money market. While mobile financial services have made some strides in engaging the rural marginalised communities, the banks still have a long way to go.

TBS: What would be your general recommendation to Bangladesh Bank to improve the efficacy of its monetary policy?

Dr Saleh Uddin: In short, Bangladesh Bank must not blindly follow conventional monetary policy instruments followed in the United Kingdom or the United States. Bangladesh Bank first needs to evaluate how its policy rates differentially affect different sections of society. For instance, how the same policy rates may affect large and small investors differently. Based on its evaluation, it can set up mixed policy rates, such as different interest rates for investors with different levels of capital. 

More importantly, it's high time the central bank put an end to corruption and discretionary power. There is a discourse regarding "Rules vs Discretion." Unless you follow the rules, discretion becomes the norm and most financial dealings in Bangladesh are executed through discretionary power. Unless BB tackles these discretionary forces, no monetary instrument will be able to bring intended results.