Policy rate hike by the central bank

The raising of policy rate, also known as interest rate, by the central bank as part of a belt-tightening move to tame inflation has produced reactions that are not unwarranted. This hike places the repo rate, the interest rate at which commercial banks borrow money from the central bank, above the inflation rate. Following the hike, the policy or repo rate now rises to 10 per cent from the existing 9.50 per cent, with effect from October 27. The regulatory move comes a day after the central bank squeezed the existing borrowing window through repo instrument for the commercial banks to once a week from the existing two days, which will create more pressure on the banks to efficiently manage their funds. The immediate reaction of the business community is that the interest rate hike will strain its existing ventures and dampen future expansion plans. This, they say, will increase borrowing costs for commercial banks from the central bank which will eventually push the lending rate up. Given this, it is generally believed that policy rate hike is followed by a decline in inflation.
According to experts, this economic principle matches a perfect economy, but given the character of Bangladesh economy, which going by economic terminology, is imperfect, the repo hike may not have the expected impact on the market. Besides making borrowing costlier, rising interest rates may lead to lower stock prices. The government may face higher interest payments, which is likely to raise public expenditure and widen the budget deficit. On the flip side, however, it is held that an increase in the policy rate can potentially attract foreign capital seeking higher returns. Additionally, higher rates may also benefit savers.
Inflation in Bangladesh fad remained relatively stable, averaging below 6.0 per cent throughout 2020 and 2021. However, by May 2022, the rate climbed to 7.42 per cent and shoot up to 9.42 per cent by August 2022. This surge was largely driven by the sanctions imposed by the European Union and the United States, which disrupted international trade and sent global market prices soaring. In the following months, inflation continued to persist at high single-digit levels, eventually crossing into double digits by mid-2024, specifically around June and July. The prolonged inflationary pressures were exacerbated by both global and local economic challenges. However, since the interim government assumed office, there has been a slight decline in inflation. This improvement can be attributed to several factors, including an influx of foreign assistance, a significant rise in workers' remittances, and the prudent monetary policies pursued by the new governor of the Bangladesh Bank.
Looking ahead, further improvement is expected as the upcoming Aman rice harvest promises to increase food supply. Additionally, with the arrival of early winter vegetables, kitchen markets are also expected to see a decline in prices, providing further relief to households struggling with rising costs. Meanwhile, it is important for the central bank to closely monitor the outcomes of the interest rate hike and, if necessary, devise innovative moves to stabilise the economy in the days ahead.