Persistent Inflation Persists Despite Rate Hikes- Can it be Tamed
When Abdur Rouf Talukder presented his initial monetary policy statement as the governor of the central bank in January last year, inflation was already exceeding 8.5 percent. Despite subsequent efforts, including one more policy statement and eight increases in the benchmark lending rate, the Consumer Price Index (CPI) has not shown signs of slowing down.
This suggests that the measures taken to address inflation have not been fully effective, and inflationary pressures persist. Inflation can be influenced by various factors, including economic conditions, supply chain disruptions, and global commodity prices. Policymakers may need to reassess their strategies and consider additional measures to bring inflation under control.
Amidst persisting inflationary challenges, the former finance secretary is set to present the Monetary Policy Statement (MPS) for the January-June period next week. This announcement comes at a time when many of the targets set in the previous policy remain unmet.
The central bank has actively sought input from economists, stakeholders, business leaders, and journalists over the past two months to formulate the new policy, addressing the ongoing economic crisis. The monetary policy committee of the central bank will convene its final meeting to finalize the MPS, which is likely to be presented to the central bank board on January 14 and made public on January 15.
The forthcoming MPS faces a challenging environment in tackling inflationary pressures, despite the central bank having increased the policy rate by more than 400 basis points in the last two years and eliminating the lending rate cap.
Inflation, standing at 9.49 percent in November, significantly surpasses the government target of 6 percent for the fiscal year 2023-24, ending in June. Inflation has exceeded 9 percent since March, posing a considerable challenge for monetary policymakers.
The governor faces two significant challenges, namely, a substantial decrease in foreign exchange reserves and the depreciation of the local currency against the US dollar. As of Monday, foreign exchange reserves stood at $20.38 billion, down from $40.7 billion in August 2021, indicating a sharp decline.
Simultaneously, the local currency has depreciated by more than 27 percent against the US dollar over the past two years. These challenges add complexity to the governor’s efforts in managing the monetary policy.
Sadiq Ahmed, the vice-chairman of the Policy Research Institute of Bangladesh, noted that the central bank has taken three noteworthy monetary policy actions to address inflation.
These actions include eliminating the controversial “6/9” interest rate policy, adopting a flexible interest rates policy, and avoiding the use of central bank resources to finance the budget deficit. These measures reflect an effort to navigate the economic challenges and stabilize the financial environment in Bangladesh.
“The main focus of the MPS should be to facilitate the sound implementation of these major changes. The interest rate should be allowed to go up until the desired inflation rate of 5-6 percent is achieved.”
In June, when the Bangladesh Bank (BB) unveiled the last Monetary Policy Statement (MPS), it largely aligned with the recommendations of the International Monetary Fund’s $4.7 billion loan program.
The removal of the 9 percent lending rate ceiling after three years marked a significant change, and the BB introduced a new rate-setting system known as the six-month moving Average Rate of Treasury bill (SMART).
Banks were permitted to add a maximum interest margin of 3.75 percent to the benchmark rate for lending. Additionally, the policy rate (repo rate) was increased from 6 percent to 6.50 percent in the MPS, later rising twice to 7.75 percent.
Despite the commitment to introduce a market-based exchange rate by September, the implementation is still pending, leading to continued exchange rate volatility. The mechanism for fixing the dollar rate by the Bangladesh Foreign Exchange Dealers Association (BAFEDA) and the Association and Bankers Bangladesh (ABB) is deemed ineffective, according to experts.
The MPS projected a 10.90 percent private sector credit growth as of December of the previous year, but central bank data for November showed that the growth stood at 9.9 percent.
The central bank has identified three challenges – exchange rate instability, high inflation, and higher bad loans – that will be addressed in the new MPS, according to central bank officials. Zahid Hussain, a former lead economist of the World Bank, emphasized that high inflation and the US dollar crisis are two major challenges facing the economy.
The economist said the central bank has introduced the SMART. “The new MPS will have to explain the outcomes of the SMART so far and how will it be operated in the upcoming days.”
“The new MPS will have to explain why the BB did not announce the market-based exchange rate within the deadline.”
According to Zahid Hussain, there is a scope to increase the interest rate margin under the six-month moving Average Rate of Treasury bill (SMART) to further raise the lending rate. This suggests that policymakers may consider adjusting the interest rate margin within the existing framework to address economic challenges, potentially impacting lending rates and influencing borrowing costs in the economy.
“The supply of the US dollar will have to be increased to tackle inflation since hiking the lending rate will not be able to bring it down alone.”
Fahmida Khatun, executive director at the Centre for Policy Dialogue, thinks higher inflation, exchange rate volatility, and lack of governance in the banking sector will have to be addressed in the monetary policy.
“If needed the banking regulator will have to hike the policy rate further. The fiscal policy and the market management will also have to be corrective.”
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Fahmida Khatoon suggests that the central bank should allow the exchange rate to be determined by the market, emphasizing that the difference between formal and informal markets will narrow if the market is allowed to make that determination.
This approach is expected to lead to an increase in the supply of US dollars, reflecting a belief that market-driven mechanisms can contribute to a more balanced and efficient foreign exchange environment.
