Money made costlier to tame inflation
It's not money supply that has caused the recent inflation, and yet the Bangladesh Bank has used the traditional monetary tool of hiking policy rates and making money costlier to manage price pressure as it does not have alternate mechanisms to control external factors.
While the banking sector is in a severe liquidity crisis, the central bank has raised the policy rates further in its new monetary policy announced for the second half of the current fiscal year 2022-23.
The central bank raised the key interest rate, also known as repurchase agreement rate (repo) at which banks borrow from the Bangladesh Bank, by 25 basis points to 6%, while reverse repo through which the central bank takes back money from banks has been raised to 4.25% from 4%.
The central bank adopted a cautiously accommodative policy stance in its new monetary programme to contain inflationary and exchange rate pressures, according to the monetary statement. However, previous experiences show that policy rate hikes cannot contain price pressure due to cost-push inflation.
Keep updated, follow The Business Standard's Google news channel
Cost-push inflation (also known as wage-push inflation) occurs when overall prices increase (inflation) due to increases in the cost of wages and raw materials.
The Bangladesh Bank Governor Abdur Rouf Talukder at the monetary policy unveiling programme said that the policy rate hike would intensify the ongoing liquidity crisis for banks but there is a solution – a refinancing scheme worth Tk50,000 crore to give low cost loans to banks.
The central bank has made money costlier to discourage banks from borrowing from the central bank, said the governor, adding that instead, banks are being encouraged to borrow from various refinancing schemes.
He maintained that banks can borrow from the refinancing schemes at lower rates when borrowing from the central bank will be expensive for them. The minimum interest rate of refinancing scheme loans is 1.5% and maximum rate is 4% when the borrowing rate from the central bank is 6%, he added.
In this process, the central bank will contain inflation by providing money from refinancing schemes for the productive sectors at lower interest rates, he added.
He also said that an increase in money supply did not create the recent price pressure, rather it was cost-push inflation, and the central bank has no mechanism to control this type of inflation. However, the central bank will keep discouraging imports and bring stability to the forex market by announcing a uniform exchange rate instead of the current multiple exchange rates to contain inflation.
The Bangladesh Bank increased policy rates three times last year when inflation kept growing as rate hikes could not suppress private sector credit demand due to the 9% lending rate cap.
The point-to-point headline inflation reached 8.71% in December 2022, which jumped to 9.5% in September, while it was 7.56% in June of the same year. During this period, the policy rate was hiked from 5.50% to 5.75%.
In the new monetary policy, the central bank has not lifted the lending rate cap. However, the lending rate cap for consumer loans has been relaxed to vary up to three percentage points along with the complete removal of the deposit floor rate.
In November last year, the central bank verbally instructed banks about the relaxation of the consumer lending rate and removal of the deposit floor rate. The new monetary policy makes that verbal instruction an official one.
Addressing this issue, the governor said, "We are waiting for a good time to lift the lending rate cap completely." In the present situation, the withdrawal of the lending rate cap will hurt investment. The lending rate cap will be lifted once the economic challenges are overcome, he added.
In the new monetary policy, the central bank has identified three external challenges for the economy including – the length and intensity of the Russia-Ukraine war, the spree of interest hikes by the Fed, and the re-emergence of the Covid-19 situation and its severity in China.
The governor said, "The easing of these challenges will expedite Bangladesh's future economic gains. However, in case of any adverse consequences of the above external issues, the Bangladesh economy has enough resilience to remain insulated in its current condition."
Money withdrawal pressure led to liquidity crisis
The Bangladesh Bank in its monetary policy notes that the money market is already in a tight spot due to vast liquidity withdrawals from the system which reflect sharply rising call money rates.
The governor also admitted to the liquidity crisis and said that in the middle of the last year, a vested quarter spread rumours about a liquidity crisis in the banking sector, which led depositors to withdraw money from banks. Later, Islami Bank became another reason for the withdrawal of deposits. However, the central bank instructed banks to allow depositors to withdraw money to restore their confidence. As a result, deposit growth slowed down. On the other hand, institutional deposits declined significantly as government organisations used their deposit money for paying high energy costs.
On the other hand, the Bangladesh Bank sold $12.4 billion to banks from January to December last amid the dollar crisis. By selling the greenbacks, the central bank mopped up Tk1 lakh crore from banks during this period.
As a result, banks fell into such a liquidity crisis that they could not buy government bonds to support the budget. In this situation, the central bank pumped back Tk65,000 crore through devolvement to support the government for budget expenditure.
Besides, a move to inject fresh money into the system by buying government bonds is in the process.
Md Habibur Rahman, chief economist of the Bangladesh Bank in his presentation on the monetary policy statement, said that surplus liquidity in the banking sector declined sharply by Tk20,285 crore in just five months to Tk6,591 crore in November last. Islamic banks saw their excess cash falling to Tk646 crore in November from nearly Tk16,000 crore in June last year.
The liquidity situation worsened even after the disbursement of special liquidity support of Tk30,000 crore by the central bank during the period, he noted, adding that huge foreign currency selling is the reason behind the stressed liquidity. If the central bank would not provide special liquidity support, the situation would get worse, he argued.
Considering the liquidity situation, the Bangladesh Bank has created a refinancing scheme of Tk50,000 crore for providing investment, employment, and production-enhancing support, he added.
How will the forex market be stable?
In the new monetary policy, the Bangladesh Bank has set the import target at $80 billion for FY23 which is 10% lower than that of the previous fiscal year. The projection reflects that the central bank will discourage imports for the next six months of FY23.
In the first six months of the current fiscal year, the country's total imports amounted to $41.2 billion which was 2.2% less compared to the same period of last year.
On the other hand, the export projection for FY23 has been set at $52.9 billion while remittance receipts are projected to be $21.9 billion.
The gap between inflow and outflow will be $5.4 billion. In the first six months of the current fiscal year, the deficit was $3.4 billion.
The Bangladesh Bank governor said that the gap between inflow and outflow will be reduced by curbing imports. As a result, the dollar market will be eased.
At the same time, the central bank will go for a unified exchange rate, which, he hoped, would reduce pressure on the balance of payment.
He also claimed that the dollar market has eased by now and banks have the capacity to open LCs (letters of credit).
What is the monetary credit ceiling?
In the new monetary policy, the central bank has kept the private sector credit growth target at 14.1% for FY23 while public sector credit growth has been revised up to 37.7% from the original 36%.
Explaining the credit ceiling, Habibur Rahman said that private credit had already slowed as the real credit growth after adjusting for global price hikes and currency depreciation was almost half from the target.
So, the 14.1% growth in private sector credit is enough for achieving the government's targeted GDP growth, he added.
The average actual credit growth was 12.8% in December last year against a monetary programme target of 13.6%, according to his presentation.
The central bank's recent study has found that although private sector credit growth has shown an increasing trend in recent months, this is not the case in reality as the high growth was due to the depreciation of taka.
The study found that private sector credit growth was 13.7%, 14%, and 13.9% in June, September, and October this year, respectively, when the exchange rate-adjusted growth was 11.9%, 10.9%, and 10.8%.
The exchange rate- and global price-adjusted growth rates were much lower at 6.6%, 7.3%, and 8.8% during the same period.
