Monetary policy alone cannot tame inflation, but can restore stability

Illustration: TBS

Although we were eagerly waiting for a new monetary policy statement (MPS) for the second half of the present fiscal year 2024-25, recent reports claiming that it will not be published in January because of the unavailability of data on key macroeconomic indicators left us astounded.

MPS FY25 was supposed to announce the revised policy rate, private sector credit growth, money supply information, inflation targets etc, which are all crucial elements of macroeconomic stability. MPS is the most important tool to announce the central bank's strategy to control price stability and money supply and revise interest rates, making the postponement a cause for despair, especially for the private sector.

While the actual reason is not known, it is theorised that Bangladesh Bank (BB) may wait for next month's inflation rate, which is expected to be lower, and based on that policy rate, may have seen some changes. However, these have not been confirmed by the concerned authority. 

The economy is suffering a serious unemployment crisis because of non-responsive investment and foreign direct investment (FDI). The government has formed several task forces and committees working in different areas to put forward recommendations to the government. But the economic situation, especially inflation, has remained uncontrolled for a long time, creating a stern impact on common people.

In the meantime, BB has arranged several discussion sessions in their internal committee with economists and bankers. 

On 14 January, there was a discussion session where the leading bankers, economists, private sector, and academia raised their viewpoints. In the presentation shared with the participants, BB has clearly identified the challenges and the action plans initiated for addressing the encounters.

Among the identified challenges, the following were the most important: expectations of high inflation, erosion of foreign exchange reserves, exchange rate pressure, tight liquidity in the banking system, tightening of global financial conditions due to rapid interest rate hikes, elevated non-performing loans (NPL), restoring good governance in banks, prolonged Russia-Ukraine war, escalating geopolitics, geo-economics, conflict in the Middle East, climate change, natural disasters, floods, heavy rainfall in September-October 2024, political movements, and labour unrest in 2024.

The most important actions taken by BB to address the challenges are tightening the monetary policy stance, increasing the policy rate by 250 basis points, transitioning from monetary targeting to an interest rate targeting framework, reducing the policy interest rate corridor from 200 basis points to 150 basis points, moving towards a more competitive market based interest rate by abolishing SMART rate in May 2024, crawling peg exchange system, allowing authorized dealers to purchase and sell foreign currency at freely negotiated rates, reference benchmark exchange rate, streamlining liquidity management, ensuring good governance and  board restructuring of banking loan classification standard.

These are all effective steps for stabilising the economic fundamentals; however, it was argued in the session that prolonged inflation may lead to stagflation, causing low economic growth and unemployment.

The policy rate has increased multiple times throughout the year, reaching 8.5% by May 2024 and further to 10% by October 2024. This means Bangladesh Bank has increased the repo rate 11 times since May 2022, aiming to anchor inflation expectations and stabilise prices. 

However, it has become clear that inflation in Bangladesh cannot be resolved by controlling monetary policy and fiscal policy alone. There is a market distortion in Bangladesh, which needs to be reduced using law enforcement. 

Supply-side analysis is essential to find out the syndicates in the market. However, experts believe that inflation came more from the supply side. The consumer price index (CPI) basket remains unchanged for too long. 

Currency devaluation is also impacting inflation. Our inflation calculation rate has a built-in bias. The indexing series should be provided. Prices of commodities will keep on increasing over time due to increased costs and technological adoption. Other countries successfully tamed inflation using policy rates, so we need to explore why it failed in Bangladesh. As long as inflation remains high, the policy rate should not decrease. Reducing the policy rate can further fuel inflation. 

Questions were raised about the spread of banks. When the policy rate (repo rate) is 10%, market-based interest rates cannot be below 16-18%. The high interest rate is putting serious pressure on businesses. Not all businesses can transfer this high cost to consumers. We need to calibrate the standing deposit facility (SDF) rate and repo rate. 

The spread rate can be reduced from 5.93% to 2%. In Sri Lanka, the spread is below 2%; in India, it was 2.96% in 2024. Because of high NPLs, up to 98% in some banks, they cannot reduce the spread rate. It appears that large corporations are being favoured while genuine small businesses are suffering.

BB should review the purchasing manager's index (PMI). The overall PMI from the Monetary Policy Unit department of BB has shown that the overall index reached 61.7, which is much higher than the July PMI of 36.9. PMI of manufacturing, services, agriculture, and construction have shown improving trends. However, the actual situation seems to contradict the PMI indicators of BB. 

There is an immediate need for a proactive credit policy for small and medium enterprises (SMEs) and startups at low interest rates. Credit risk is involved with the exporters' exchange rate. The difference between private commercial banks (PCBs) and foreign commercial banks (FCBs) should be distinguished as the PCBs are heavily dependent on remittance, but the FCBs are not.

The cautiousness and conservative approaches of BB on freezing the bank accounts could have had a negative impact. The refinancing schemes of BB are for cottage, micro, small, and medium enterprises (CMSME) but are not actually able to support cottage and micro entrepreneurs. Its realisation starts from the medium and then follows a descending order. The cottage industry does not receive any of the finance. Other costs are associated with interest rates for the private sector. A special refinance scheme should have been formulated for these petite entrepreneurs.

The discussions raised several questions: How much of the aggregate demand has been reduced due to contractionary monetary policy? How much of the consumer, industrial and other credit has declined? How is liquidity support being provided to the stressed banks? etc. An assessment of monetary policy in inflation should have been made. In December, the private sector credit growth was 7% and that of the public sector was 19%, indicating a lack of coordination between fiscal policy and monetary policy. Why is the public sector borrowing high despite a contractionary fiscal policy?

Income from remittance is low; in international markets, our aggregators are low. We should have our own international payment gateway for remittance. The aggregators from the Middle East were dictating the exchange rate. Action should be taken against them. Some of the banks are buying foreign currencies at a higher rate and misreporting them to BB, which is unacceptable. Experts suggest that there should be a range of exchange rates for the exporters instead of uniform rates.

There should not be any varied exchange rate in the floating exchange rate regime. There is a tendency to dictate exchange rates in different ways. Some of the discussants suggested that we should get out of the crawling peg quickly. Market transparency is essential to address the volatility in the forex market. The digital dashboards need to be made effective for the banks where they will display the exchange rates. 

Imposing new VAT on 100 products will squeeze the middle and lower-middle class. About 80% of the people of the country will not be able to bear this. The new VAT ordinance targets collecting more than Tk1000 crore from the SMEs. The turnover tax ceiling for SMEs has been reduced, and the VAT exemption amount has been reduced, too. VAT will impact the local small RMGs. Our loan-to-GDP ratio is 60%, whereas it is 100% for other countries. What is our foreign debt servicing capacity? There needs to be more clarity. Trust among existing and new investments needs to be retained and continued at any cost.

Investment credit growth needs assessment. If there is high liquidity, the interest rate should be low to ensure more investment. Different companies have fired over 1.5 lakh workers. In this situation, investment is of paramount importance. There is no product for long-term investment. We could not bring investment from the remitters. Tapping the potential of attracting foreign investors and the diaspora community in the stressed banks could be an option. 

We expect the new MPS soon so that the strategies for macroeconomic stability are restored so that investment and employment can get a new push in the coming fiscal year.

Although we were eagerly waiting for a new monetary policy statement (MPS) for the second half of the present fiscal year 2024-25, recent reports claiming that it will not be published in January because of the unavailability of data on key macroeconomic indicators left us astounded.

MPS FY25 was supposed to announce the revised policy rate, private sector credit growth, money supply information, inflation targets, etc, which are all crucial elements of macroeconomic stability. MPS is the most important tool to announce the central bank's strategy to control price stability and money supply and revise interest rates, making the postponement a cause for despair, especially for the private sector.

While the actual reason is not known, it is theorised that Bangladesh Bank (BB) may wait for next month's inflation rate, which is expected to be lower, and based on that policy rate, may have seen some changes. However, these have not been confirmed by the concerned authority. 

The economy is suffering a serious unemployment crisis because of non-responsive investment and foreign direct investment (FDI). The government has formed several task forces and committees working in different areas to put forward recommendations to the government. But the economic situation, especially inflation, has remained uncontrolled for a long time, creating a stern impact on common people.

In the meantime, BB has arranged several discussion sessions in their internal committee with economists and bankers. 

On 14 January, there was a discussion session where the leading bankers, economists, private sector, and academia raised their viewpoints. In the presentation shared with the participants, BB has clearly identified the challenges and the action plans initiated for addressing the encounters.

Among the identified challenges, the following were the most important: expectations of high inflation, erosion of foreign exchange reserves, exchange rate pressure, tight liquidity in the banking system, tightening of global financial conditions due to rapid interest rate hikes, elevated non-performing loans (NPL), restoring good governance in banks, prolonged Russia-Ukraine war, escalating geopolitics, geo-economics, conflict in the Middle East, climate change, natural disasters, floods, heavy rainfall in September-October 2024, political movements, and labour unrest in 2024.

The most important actions taken by BB to address the challenges are tightening the monetary policy stance, increasing the policy rate by 250 basis points, transitioning from monetary targeting to an interest rate targeting framework, reducing the policy interest rate corridor from 200 basis points to 150 basis points, moving towards a more competitive market based interest rate by abolishing SMART rate in May 2024, crawling peg exchange system, allowing authorized dealers to purchase and sell foreign currency at freely negotiated rates, reference benchmark exchange rate, streamlining liquidity management, ensuring good governance and  board restructuring of banking loan classification standard.

These are all effective steps for stabilising the economic fundamentals; however, it was argued in the session that prolonged inflation may lead to stagflation, causing low economic growth and unemployment.

The policy rate has increased multiple times throughout the year, reaching 8.5% by May 2024 and further to 10% by October 2024. This means Bangladesh Bank has increased the repo rate 11 times since May 2022, aiming to anchor inflation expectations and stabilise prices. 

However, it has become clear that inflation in Bangladesh cannot be resolved by controlling monetary policy and fiscal policy alone. There is a market distortion in Bangladesh, which needs to be reduced using law enforcement. 

Supply-side analysis is essential to find out the syndicates in the market. However, experts believe that inflation came more from the supply side. The consumer price index (CPI) basket remains unchanged for too long. 

Currency devaluation is also impacting inflation. Our inflation calculation rate has a built-in bias. The indexing series should be provided. Prices of commodities will keep on increasing over time due to increased costs and technological adoption. Other countries successfully tamed inflation using policy rates, so we need to explore why it failed in Bangladesh. As long as inflation remains high, the policy rate should not decrease. Reducing the policy rate can further fuel inflation. 

Questions were raised about the spread of banks. When the policy rate (repo rate) is 10%, market-based interest rates cannot be below 16-18%. The high interest rate is putting serious pressure on businesses. Not all businesses can transfer this high cost to consumers. We need to calibrate the standing deposit facility (SDF) rate and repo rate. 

The spread rate can be reduced from 5.93% to 2%. In Sri Lanka, the spread is below 2%; in India, it was 2.96% in 2024. Because of high NPLs, up to 98% in some banks, they cannot reduce the spread rate. It appears that large corporations are being favoured while genuine small businesses are suffering.

BB should review the purchasing manager's index (PMI). The overall PMI from the Monetary Policy Unit department of BB has shown that the overall index reached 61.7, which is much higher than the July PMI of 36.9. PMI of manufacturing, services, agriculture, and construction have shown improving trends. However, the actual situation seems to contradict the PMI indicators of BB. 

There is an immediate need for a proactive credit policy for small and medium enterprises (SMEs) and startups at low interest rates. Credit risk is involved with the exporters' exchange rate. The difference between private commercial banks (PCBs) and foreign commercial banks (FCBs) should be distinguished as the PCBs are heavily dependent on remittance, but the FCBs are not.

The cautiousness and conservative approaches of BB on freezing the bank accounts could have had a negative impact. The refinancing schemes of BB are for cottage, micro, small, and medium enterprises (CMSME) but are not actually able to support cottage and micro entrepreneurs. Its realisation starts from the medium and then follows a descending order. The cottage industry does not receive any of the finance. Other costs are associated with interest rates for the private sector. A special refinance scheme should have been formulated for these petite entrepreneurs.

The discussions raised several questions: How much of the aggregate demand has been reduced due to contractionary monetary policy? How much of the consumer, industrial and other credit has declined? How is liquidity support being provided to the stressed banks? etc. An assessment of monetary policy in inflation should have been made. In December, the private sector credit growth was 7% and that of the public sector was 19%, indicating a lack of coordination between fiscal policy and monetary policy. Why is the public sector borrowing high despite a contractionary fiscal policy?

Income from remittance is low; in international markets, our aggregators are low. We should have our own international payment gateway for remittance. The aggregators from the Middle East were dictating the exchange rate. Action should be taken against them. Some of the banks are buying foreign currencies at a higher rate and misreporting them to BB, which is unacceptable. Experts suggest that there should be a range of exchange rates for the exporters instead of uniform rates.

There should not be any varied exchange rate in the floating exchange rate regime. There is a tendency to dictate exchange rates in different ways. Some of the discussants suggested that we should get out of the crawling peg quickly. Market transparency is essential to address the volatility in the forex market. The digital dashboards need to be made effective for the banks where they will display the exchange rates. 

Imposing new VAT on 100 products will squeeze the middle and lower-middle class. About 80% of the people of the country will not be able to bear this. The new VAT ordinance targets collecting more than Tk1000 crore from the SMEs. The turnover tax ceiling for SMEs has been reduced, and the VAT exemption amount has been reduced, too. VAT will impact the local small RMGs. Our loan-to-GDP ratio is 60%, whereas it is 100% for other countries. What is our foreign debt servicing capacity? There needs to be more clarity. Trust among existing and new investments needs to be retained and continued at any cost.

Investment credit growth needs assessment. If there is high liquidity, the interest rate should be low to ensure more investment. Different companies have fired over 1.5 lakh workers. In this situation, investment is of paramount importance. There is no product for long-term investment. We could not bring investment from the remitters. Tapping the potential of attracting foreign investors and the diaspora community in the stressed banks could be an option. 

We expect the new MPS soon so that the strategies for macroeconomic stability are restored so that investment and employment can get a new push in the coming fiscal year.

Sketch: TBS

Ferdaus Ara Begum is the CEO of BUILD, a public-private dialogue platform that works for private sector development.

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.