Bangladesh Bank is struggling to create a stable and healthy macroeconomic environment as it stumbles with an upward inflation rate and exchange rate instability. When the Central Bank decides to increase the money supply, it is an expansionary monetary policy, and when the money supply is decreased, it is a contractionary monetary policy. The government uses these policies to influence investment, employment, output, and income.

The new monetary policy for the first half of FY24 brings four key reforms: the implementation of a policy interest rate corridor, the establishment of a reference interest rate for lending, exchange rate unification, and a revised approach to calculating the gross international reserve according to the BOP and International Investment Position Manual. The goal of the new monetary policy is to keep inflation within 6%, aligning with the target of the Bangladesh government.

Market-driven reference lending rate

Bangladesh Bank governor Abdur Rouf Talukder unveiled the new monetary policy for July-December of FY 2023-24 on June 19, marking a shift from a monetary targeting approach to an interest rate targeting framework. This contractionary monetary policy adopts a new interest rate regime in Bangladesh, where the interest rate cap of 6%-9% is replaced with a market-driven reference rate. 

For a long time, the central bank remained rigid in regulating the interest rates strictly determined by the market due to the fear that it might kill the competitiveness of the private sector. The ‘SMART’ reference lending rate will be calculated as the six-month moving average treasury bills rate. A 3% margin is for banks, and a 5% is for non-bank financial institutions. There will be no changes in the interest rates applicable to credit card loans. However, economists expressed skepticism about whether the new lending rate formula promotes market-based lending rates and if it would help reduce inflation.  

Increasing policy rates

The Bangladesh Bank makes decisions on interest rates by controlling two policy interest rates. The repurchase rate (repo rate) is used to add money into the banking system, and the central bank uses the reverse repo rate to borrow from commercial banks, often overnight. As part of the contractionary monetary policy, Bangladesh Bank increased the repo rate to 6.50% and the reverse repo rate to 4.50%, effective from July 1. An increased repo rate means when banks borrow money from the central bank, they will have to pay more interest during this period. This restrains banks from borrowing money, reducing money supply in the market and slowly diminishing inflation. An increase in the reverse repo rate falls under the contractionary monetary policy, which reduces the money supply and, consequently, inflation.

Unified and market-driven single exchange rate regime

Bangladesh Bank plans to implement a unified and market-driven single exchange rate so that market forces can determine the exchange rate between the local, taka, and other foreign currencies. Therefore, Bangladesh Bank is promoting stability in the foreign exchange market as it no longer quotes specific rates for buying or selling foreign exchanges. 

Bangladesh Bank used to quote different exchange rates for exports, imports, and remittances. The exchange rate of remittance was more favorable for business. To benefit from the higher quoted remittance exchange rate, exporters took advantage of bringing USD into the country as remittance rather than export proceeds. This is also one of the reasons for inflation in our country.  

Calculating the gross international reserve

Bangladesh Bank will calculate and publish gross international reserves (GIR) following the sixth edition of the IMF’s BOP and International Investment Position Manual (BPM6). Meanwhile, the central bank will keep track of current practices of calculating and reporting total foreign assets. 

Bangladesh Bank has liabilities of nearly USD4 billion (July 2023). As per BPM6, the central bank must calculate the net reserve, excluding liabilities from the gross reserve. Moreover, the central bank must calculate this gross reserve, excluding foreign currency loans to local banks, deposits with state-owned local banks, and many more. 

For the FY23-24 budget, the expected GDP growth is 7.5 %, and inflation is 6 %. Is this contractionary monetary policy good enough to stop inflation? The annual inflation rate in Bangladesh eased slightly from 9.94% in May to 9.74% in June 2023. The inflation remains alarming as the prices of daily necessities in the market are still high. In this situation, an expansionary policy can be dangerous. Therefore, Bangladesh Bank did the right thing by focusing on inflation reduction. 

The future of a country’s economy depends on how well its balance of payments is working. Stability and growth in the current account balance require a high level of exports and large amounts of remittance inflows. To cover the deficit from FY23, the government plans to take loans from the banking sector and foreign sources. Whether the Bangladesh Bank will provide domestic loans remains a question. 

Sometimes, the Central bank has to print money to support the budget. However, if the central bank prints money too frequently, then the system becomes complicated. Bangladesh Bank created fresh money of more than BDT 50,000 crore in the July-December period of 2022 for budget support, the highest amount of money printed in recent history. The government borrowed this amount to provide budget expenses. 

When banks have enough liquidity, they participate in government bond auctions called by Bangladesh Bank to invest in government bonds through which money is collected for the budget. However, a serious dollar crisis dried up banks’ liquidity this year. Consequently, banks are seeking dollars from the Bangladesh Bank, and the local currency is ending up in the central bank. The climbing rate on government bonds in Bangladesh shows a liquidity crisis. 

During this liquidity crisis, banks put high interest rates, which the central bank is unwilling to take. In this situation, the Bangladesh Bank has started to print taka to supply money to the government instead of the government borrowing money from commercial banks. But, printing fresh money will impose strong challenges against fighting inflation. How will the government of Bangladesh possibly drop the inflation rate from 9% to 6% if it takes loans by printing more money? 

The US provided its citizens stimulants during COVID-19 by printing more money. And yet, the US economy has shown no signs of falling apart, whereas there is fear of another Sri Lanka case for Bangladesh’s economy. One may ask what makes the US economy different. Most of the trade around the world is done in the US dollar. Central banks around the world keep dollars in their foreign reserves. Hence, the global demand for the dollar is sufficiently large to absorb any excess supply of the US dollar, so much so that the nation can get away with printing more money.  

The developing and least developed countries cannot afford to print or borrow money like the USA because the demand for their currencies in the international market is insignificant. It is difficult and almost impossible for countries like Bangladesh to create enough demand for their currency in the global market to cover up domestic economies from inflationary pressure. The central bank believes the new monetary policy will work smoothly if the global economy stabilizes and war-related disruptions normalize. 

Many countries, including China, Russia, and India, are already searching for a reliable substitute for the US dollar, given the global economic instability due to the Ukraine vs. Russia war. The worldwide dollar crisis and the high inflation level have moved many countries’ attention towards buying gold to reduce dependency on dollars. This act of Central banks around the world has led to an increase in the purchase of gold by more than 400% compared to last year, which is approximately 399.3 tonnes of gold bought from July to September 2022. This is something the Bangladeshi policymakers should reflect upon, too.

Central banks are essential in controlling inflation by setting certain interest rates. However, they don’t have the necessary tools to get inflation down. During an economic crisis, it is normal for any Central Bank to increase the money supply as it will provide additional resources. An excess of money may diminish the effects of the interest rate needed to drag down inflation. Besides, other dynamics drive price increases that do not respond to changes in interest rates. 

However, the policymakers are optimistic. The contractionary policy holds that market participants already have excessive money, raising prices and pushing inflation. So, the money needs to be taken back from the society.