Decoding the first Monetary Policy Statement of fiscal year 2023-24: Was there any better alternative?

Illustration: TBS

On 18 June 2023, Bangladesh Bank (BB) released the policy statement for the first half (July-December) of FY 2024. This Monetary Policy Statement (MPS) was very different from the previous one and addressed almost all the key issues needed to align with the conditions of the IMF. 

However, there are still criticisms surrounding the MPS, and those criticisms, to some extent, are creating dissatisfaction in different economic clusters of the country. Thus, BB's MPS demands to be scrutinised from a comprehensive perspective.

Clarity and Direction

Unlike the previous MPS, this MPS is clear and bold, just as a central bank's MPS should be. The MPS has clearly defined itself as a contractionary monetary policy and has a clear objective of containing inflation. 

The previous MPS had several goals, which made the direction of the MPS vague, and this is why specific policies were difficult to implement successfully. However, as the first and foremost objective of this MPS is to contain inflation, it was easier to direct policy initiatives.

Was the contractionary monetary policy stance to contain inflation justified?

Covid-19 and the Russia-Ukraine war-led inflation have already made the global economy take a roller coaster ride. However, according to the IMF's prediction, inflation is expected to fall to 6.6% this year from 8.8% in 2022, and in 2024 it will further decline to 4.3%. As the prediction states, inflation is coming down gradually. However, this has no reflection on the commodity prices of Bangladesh.

According to the Consumer Price Index, the point-to-point inflation reached 9.94% in May 2023. This rate is alarming, and the effect is seen in the commodity market very clearly. So, there was no scope to take an expansionary policy. As domestic commodity prices are becoming a headache for the citizens, Bangladesh Bank did the right thing by setting its objective to contain inflation.

Four Policy Initiatives

Firstly, BB will transition from a money-targeting framework to an interest rate-targeting one. The interest rate targeting framework makes it easier to influence the market and provides more flexibility than the former one. It also assists in absorbing economic shocks and provides scope for reacting in an efficient way. 

For the first half of FY24, conforming to the tight MPS, BB set the policy rate to 6.5%, 0.5% higher than the current one. The reverse repo rate was also adjusted to 0.25% higher and set at 4.5%. This will ultimately raise the cost of borrowing and discourage the market from taking additional loans and will limit CPI inflation eventually.

Secondly, BB has announced the withdrawal of the lending cap and introduced a market-driven reference lending rate for all types of bank loans. Although every stakeholder of the economy knew BB would adhere to the conditions of the IMF and withdraw the cap, the introduction of the reference rate was very creative and praiseworthy. BB had to impose the lending cap in a situation where the lending rate had swollen up to 20%. This was increasing the cost of funds and was one of the biggest hurdles in the growth of the private sector of the country. 

Thus, the imposition of a cap was necessary. But if BB had decided to withdraw the cap simply, the lending cost would have again gone out of control. So, what BB has done was to innovate a reference rate-SMART (Six-month moving average rate of Treasury bill) for Bangladesh. Such reference rates like EFFR (Effective Federal Fund Rate) and LIBOR (London Interbank Offered Rate) are also used globally.

Currently, as per BB's website, SMART is 7.13%. A margin of 3% and 5% can be added to the rate for bank loans and NBFI loans, respectively, but no more than 2% in the case of agricultural and rural loans. BB has also taken into consideration the cost of supervision for CMSMEs (Cottage, Micro, Small, and Medium Enterprises) and has allowed an additional 1% margin for CMSMEs.

Thirdly, BB is adopting a unified and market-driven single exchange rate regime. This is expected to bring down economic malpractice. In simple words, previously, BB used to quote different exchange rates for export, import, and remittances. The exchange rate of remittance was more favourable, and dishonest businessmen were taking advantage of that. 

They used to bring USD into the country as remittance rather than export proceeds to benefit from the higher quoted remittance exchange rate. This also caused inflation domestically. BB's decision to adopt the unified and market-driven single exchange rate regime will thus reduce economic fraud and stop arbitrage opportunities.

Lastly, another condition of the IMF that BB is abiding by is to calculate foreign reserves as per the IMF's guideline- BPM6. In BPM6, the central bank is to report only that portion of foreign reserves that is ready to be utilised right now. However, BB has been reporting its Foreign Reserve in a different format for a long time. 

Thus, the sudden shift to a new process might mislead the country's economic condition and create panic. So, BB has decided to use both formulas: the current one for consistency and IMF's BPM6 for reporting internationally. This is another commendable decision taken by BB.

The criticisms regarding the MPS

There were criticisms saying this MPS would slow down the growth. As the lending cap has been withdrawn and BB is tightening its MPS, the cost of funds for private firms will increase. It will make their overall cost of business go up, and firms may fail. As per the economic formula, the predictions are not wrong. 

However, the criticism is totally invalid. Those who are coming up with such narratives perhaps have ignored only one word mentioned in bold blocks - "Contractionary." Contractionary policy, by its very nature, means that market participants have excessive money in their hands, and this is one of the reasons why inflation is going up. 

So, the money needs to be taken back from them. To do so, the interest rate is increased. Thus, it was very natural for the central bank to increase its policy rate. If not, the critics could have provided a better alternative MPS for the upcoming six months rather than only prioritising the cost of funds. It seemed like they wanted inflation to go down while keeping the cost of funds low. 

Undoubtedly, this is the ideal scenario, but in reality, is it an achievable target given the current condition of the market? Probably not.

Can the MPS achieve its target of containing inflation?

Realistically, it is not just the MPS that controls the market. However, it is the primary and most fundamental tool of a country's central bank. Bangladesh Bank (BB), through its MPS, can control other banks and NBFIs in our country. But the current inflation or price hike is not just a product of interest rates.

To contain inflation, fieldwork is a must. People who held the restrictions in LC opening liable for higher inflation, is it the real cause? Imports have been restricted, not stopped. First of all, for essential commodities, Bangladesh does have the capacity to satisfy its needs through domestic production. On top of that, the government is allowing the imports of daily essentials and continued imports. Thus, it would be partially wrong to blame the import restriction for the price hike.

To curb domestic inflation, market monitoring has no other alternative in today's circumstances. Some might argue that the "Directorate of National Consumers' Right Protection'" is conducting market monitoring, then why is inflation not contained? One needs to understand which part the directorate is working on. The organisation is working at the last stage of price setting. Starting from production to the final labelling of MRP, market monitoring needs to be conducted. At each and every level, if the price is regulated or checked, only then can domestic inflation be brought down.

One of the strengths of this MPS was the recognition of its own limitations. BB has addressed that there are challenges in the effective implementation of the MPS. BB needs to make sure it doesn't print money just to ensure loan disbursement and, if possible, try to liaise with other stakeholders of the economy to curb inflation in the domestic market. 

The outcome of the MPS might not meet its objective because of a wide range of factors. But the MPS that BB constructed this time was the best alternative and unique of its kind.

Dr Ashraful Alam Chowdhury is an Independent Researcher and Columnist. He completed his MSS in economics from Dhaka University and PhD from Emory University, Georgia, US.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.