Monetary policy and political turmoil

Monetary policy in some cases is more important than the fiscal policy. It assumes more importance in an economy where market instruments are used increasingly. The monetary policy the Bangladesh Bank (BB) had been pursuing since July 2010 drew criticisms as it persistently pledged curbing of inflation in the economy. The policy did not take note of what was happening to investment because of such a policy.
By targeting only inflation or by over-emphasising the need for containing inflation, the BB failed to take care of the need for investment in the economy. Targeting lowering of inflation as the main goal of the monetary policy, the BB put a ceiling on broad money expansion and credit flow to the private sector as well.
The economy had been receiving an increasing investment up to June 2010, but with the adoption of an inflation-curbing policy, which, by nature, is a contractionary one, the BB tried to implement it by fixing a ceiling on the private sector credit flow. Before July 2010, the private sector credit growth was on average more than 20 per cent but the Monetary Policy Statement (MPS) announced for July-December 2010 period brought it down to 18 per cent or so. The subsequent monetary policy reduced the ceiling on the growth further.
Finally, the last half-yearly monetary policy announced in July 2014 brought down the targeted private sector credit flow to 15.5 per cent though that too was not achieved due to sluggish demand for investment funds in the economy. The Bangladesh economy was receiving less-than-required investment for a growth rate of 7-7.5 per cent, targeted by the government.
Since July 2010, interest rate in the economy started going up and investment demand for money behaved just the opposite though those were the days of stability, politically. A sudden change in the monetary policy pushing interest rate high made the fund for investment costly and the investors responded to the situation by investing less. That of course brought down inflation in the economy that the BB had wanted, but at a cost of having low investment.
The Bangladesh economy since then entered into one kind of low-performing one and the hope of achieving 7.0 per cent growth rate or higher seemed to have fizzled out. As the banks no longer could borrow funds at a lower interest rate from the BB, they started hiking lending rates. People with surplus funds took the funds out of government-sponsored saving schemes and also from the stock market investment. They deposited the same in the commercial banks as long-term deposits at higher interest rates. The BB, in addition to increasing its own discount rate, asked the banks to raise cash reserve ratio (CRR). These policies were aimed at reducing the supply of money to the economy.
The BB attained its target. Within a few months, the investors saw a big rise in interest rates in every sector. Consumer loan was discouraged by the BB. The central bank started identifying which investment was productive and which one was not and which investment should have priority in loan disbursement.
The BB did not stop in announcing a tight monetary policy; it also became very active in dictating banks' loan disbursement policies. Banks found it difficult to choose the clients and within one year, they were found to be sitting on a huge amount of idle funds. Banks' business experienced a big decline; most of the banks' balance sheets turned poorer. Banks could not re-loan the idle money nor could they recover the disbursed loans.
Unfortunately, the BB pursued a policy which depressed investment demand in the economy in the name of a monetary policy which only targeted curbing of inflation. It failed to consider that in an economy like Bangladesh which has a huge supply potential, inflation could have been tamed by increasing production and that could have been made possible only by having more investment in the economy.
True, when the BB announced a tight monetary policy putting a lower ceiling on the private sector credit growth, the inflation rate in the economy was above 8.0 per cent per annum. But nobody calculated what portion of that inflation was monetary phenomenon and what part was contributed by other factors.
A tight monetary policy or inflation-curbing monetary policy is suitable for the fully-employed market economies where most of the increase in price level can be attributed to more money supply. But in an economy like that of Bangladesh where inflation cannot be a monetary phenomenon in a situation of increased production from additional investment, using a monetary policy to curb inflation will only discourage investment or put a curb on the increase in supply and thereby push the economy down to a level less than its potentials.
Political disturbances affected the Bangladesh economy in 2013. These have now resurfaced with growing severity. Unfortunately, the shaking of confidence on the economy due to political chaos is now rendering all policies, whether good or bad, non-functional.
The monetary policy the BB announced on January 29, 2015 was just the continuation of the previous half-yearly one. Interest rate in the economy is still high. Only a changed monetary policy which should target lowering of discount rate in its open market operation can help the market interest rates go down to an extent. The BB's very monetary policy is partly responsible why the Bangladeshi borrowers are opting for borrowing from the foreign capital market.
Main concern had always been with low investment in the economy and the BB's monetary policy was blamed partly for that. But now, even with an expansionary monetary policy and with low interest rates, investment demand will not pick up due to political turmoil that has gripped the economy. No amount of incentive or no low rate for borrowing will put the economy on a normal performing path unless bad politics ends first. Confrontational politics has been driving capital out of Bangladesh.
The writer is Professor of Economics, University of Dhaka.  abuahmedecon@yahoo.com