Monetary policy faces fresh challenges

Asjadul Kibria | Published: July 27, 2024 19:40:47

The latest monetary policy, declared two weeks ago, seeks to keep the growth of domestic credit flow at a moderate level during the first half of the current fiscal year (FY25). It wants to keep the growth of private credit unchanged while allowing the public sector credit grow to a certain extent during the period. The Bangladesh Bank (BB) had maintained the same stance during the immediate past fiscal year.
As the share of credit to the private sector is around four-fifths of the domestic credit, the central bank does not have any option other than containing the private credit flow to ensure its tight monetary stance, as declared in the latest monetary policy.
The Monetary Policy Statement (MPS) for the first half of FY25 categorically said that Bangladesh would maintain a cautiously tight monetary policy stance, keeping the policy (Repo) rate at 8.50 per cent, the SDF rate at 7.0 per cent, and the SLF rate at 10.0 per cent unchanged. "Additionally, BB will continue quantitative tightening by streamlining Open Market Operations, ceasing currency swaps among banks and BB, and refraining from creating new money for government spending," it added.
As the hike in the policy rate in the last fiscal year curbed the growth of private credit significantly, Bangladesh Bank expects that higher lending rates would continue to discourage the private sector from borrowing from the banking sector. The repo rate was increased from 6.0 per cent to 8.50 per cent throughout FY24. The repo rate is at which the BB lends money to commercial banks in case of any shortfall of funds. So, a higher repo rate means a higher cost of borrowing for the banks. International Monetary Fund (IMF) had suggested enhancing the repo rate to 9.0 per cent by December next or the end of the first half of FY25. A slowdown in private credit is expected to reduce the pace of inflation in the coming months.
The central bank also said that it would not print money to finance the government's budget deficit. This stance is critical, as printing money means issuing high-powered money that increases the monetary base and enhances the supply of money in the market. The net outcome is an increased inflation.
How successful will the central bank be in maintaining its declared tight monetary stance? Though it is difficult to give a clear-cut answer, one thing is certain: the BB will be under pressure to relax the tight monetary stance soon, mainly due to the evolving situation in the country.
The central bank has designed the latest monetary policy, presuming that political stability will continue. However, when it announced the MPS formally on July 18, the situation had already turned volatile following the students' movement for quota reform. The situation deteriorated rapidly, and violence erupted in Dhaka and many other places in the country. Violent incidents led to several deaths, more than 200, and thousands of injuries. Public and private properties were damaged making the situation worse. To control the destructive situation, the government has finally imposed a nationwide curfew and announced public holidays. The damage caused to the data centres and the cautionary moves also led to a week-long broadband internet shutdown across the country. Though broadband has become operational, mobile internet is still shut. Thus, internet disruption has caused enormous loss to businesses. Exports and imports have stalled, internal commercial activities are almost suspended, and the supply chain has broken down. Internet-based freelancing was also severely affected.
All these have already taken a heavy toll on the national economy, although no concrete estimate is available until now. Recouping economic losses will be difficult, and almost impossible in a few cases. The sudden and unforeseen changes on the domestic front make it difficult to pursue the just-declared monetary stance for obvious reasons.
The central bank's standpoint to keep the policy rate unchanged until December this year is backed by some assumptions. It had expected that inflation will gradually subside in the next few months, thus, easing pressure to hike policy rate up further. Fall in inflation would also ultimately open room for rate cut giving signals to the banks to enhance credit disbursement. The decisions made by the central bank carry significant weight and can profoundly impact the economy. The annual average inflation stood at 9.73 per cent at the end of June last year, and the BB wants to bring it down to around 6.50 per cent at the end of FY25, or by end of June next, to be precise.
In the changed scenario, inflation seems unlikely to be moderated, as full supply chain restoration will take some more time. Already, prices of essentials and many other goods and services have jumped due to a breakdown in the domestic supply chain and disruption in imports. So, the risk of higher inflation is now there. In that case, the central bank may face pressure to hike the rate up further, making lending even costlier.
Though containing inflationary pressure is the prime duty of the central bank, it also has a subsequent task of supporting growth momentum. The government has set a target to achieve 6.75 per cent growth of gross domestic product (GDP) in FY25, which was estimated at 5.82 per cent in the last fiscal year. The damage caused to public properties and disruption to economic activities during the last two weeks will affect economic growth negatively. Demand for money will increase to support economic recovery, forcing the monetary stance to relax soon. The BB may even cut the policy rate in extreme cases, reversing the course of monetary tightening. Moreover, the central bank may also print money against its declared stance to support the government's budget deficit.
In sum, the central bank of the country is likely to face unprecedented challenges if it keeps the just declared monetary policy stance unchanged. It may also have to make certain compromises to rein in inflation. This situation underscores the need for fiscal policy support on an urgent basis. The importance of this measure cannot be overstated.
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