Expansionary monetary policy to stimulate investment

A monetary policy is referred to as contractionary if it reduces the size of money supply or raises interest rate. An expansionary policy increases the size of money supply or decreases the interest rate. Furthermore, monetary policies are described as accommodative if the interest rate set by the central monetary authority is intended to spur economic growth; neutral if it is intended to neither spur growth or combat inflation, or tight if it is intended to reduce inflation. There are several monetary policy tools available to achieve these ends. Increasing interest rates by fiat, reducing the monetary base or increasing reserve requirements all have the effect of contracting the money supply, and, if reversed, expand the money supply.

Since the 1970s, the monetary policy has generally been formulated separately from fiscal policy. And even prior to the 1970s, the Bretton Woods system ensured that most countries  would form the two policies separately.

The monetary policy rests on relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. It uses a variety of tools to control one or both of these to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). The beginning of the monetary policy as such comes from the late 19th century where it was used to maintain the gold standard.

The primary tool of the monetary policy is open market operations. This entails managing the quantity of money in circulation through buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation.

ROLE OF MONETARY POLICY: The central bank is the sole issuer of banknotes and bank reserves. By virtue of this monopoly, it can set conditions at which banks can borrow from the central bank. Therefore, it can also influence the conditions at which banks trade with each other in the money market.

In the short run, a change in money market interest rates induced by the central bank sets in motion a number of mechanisms and actions by economic agents. Ultimately, the change will influence developments in economic variables such as output or prices. This process - also known as the monetary policy transmission mechanism - is highly complex. While its broad features are understood, there is no consensus on its detailed functioning.

It is widely agreed that in the long run after all adjustments in the economy have worked through a change in the quantity of money in the economy. This will be reflected in a change in the general level of prices. But it will not induce permanent changes in real variables such as real output or unemployment.

INFLATION - A MONETARY PHENOMENON: Inflation is a monetary phenomenon. Prolonged periods of high inflation are typically associated with high monetary growth. While other factors (such as variations in aggregate demand, technological changes or commodity price shocks) can influence price developments over shorter horizons, over time their effects can be offset by a change in monetary policy.

Since monetary policy goals cannot be influenced directly, like most central banks, the Bangladesh Bank (BB) uses a set of indirect instruments. As noted above, the BB pursues its monetary policy within a framework of monetary targets with reserve money as operating target, and broad money as an intermediate target. The Flow Chart on the Monetary Policy Framework provides a simple illustration.

The broad money (M) can be influenced indirectly by changes in policy instruments that target and monitor the reserve money (RM) via the money multiplier (m). The primary mechanism employed for this purpose is the direct control of liquidity on a day-to-day basis achieved by the ratio, reverse-ratio and the weekly T-bill auctions. The latter instruments would, in turn, have an impact on the inter-bank call money rate for overnight transactions.

The Monetary Policy Statement (MPS) H2 FY '16 has made a shift from the monetary stance of last couple of years with a larger focus on growth by rate cut and increase in money supply. In our observation, inflation may drop further and growth target is attainable due to improved political stability. Overall, the policy stance can be viewed as 'Step towards Expansionary'.  The BB has shown all intentions of spurring the economy which is aiming a trajectory towards 7.0 per cent GDP (gross domestic product) growth. The central bank, after a long period of time, has reduced the policy rates by 50 basis points. Higher growth rate has been targeted for Broad Money, Domestic Credit, Public Sector Credit and Private Sector Credit in June 2016 compared to the actual growth achieved in December 2015.

Broad Money (M2) growth has been targeted at 15 per cent for FY16 which was at 12.4 per cent in 2014-15. The target has been set after taking the public and private sector credit growth into consideration. M2 is adequate to support the growth and inflation target of the BB.

General inflation is in a downward trend but a rise in non-food inflation remains a concern. Inflation has been well managed in recent years while general inflation has dropped from above 7.0 per cent of mid-2014 to 6.1 per cent in December 2015. The decline can be attributed to depressed global commodity market and falling fuel price. Moreover, the food component occupies about 60 per cent of our consumption basket and the price of food is falling all over the world.

Repo rate of 7.25 per cent has been reduced to 6.75 per cent and reverse repo rate of 5.25 per cent has been lowered to 4.75 per cent. The BB expects to stimulate investment in the economy to achieve higher GDP growth target in the upcoming fiscal year. Meanwhile, yields on T-bill and T-bond are falling followed by call money rate because of excess liquidity in the economy.

Both public and private sector credit growth undershot the targets for December 2015. Public sector credit growth was -1.7 per cent compared to the target of 8 per cent while private sector credit growth was 13.8 per cent compared to the target of 14.3 per cent for December 2015. As a result, total domestic credit growth was 14.2 per cent compared to the target of 15 per cent. The BB has revised down its June 2016 target mentioned in its MPS of June 2015 to an achievable level. It targets domestic credit growth rate of 15.5 per cent, public sector credit growth of 18.7 per cent and private sector credit growth target of 14.8 per cent for June 2016.

Bangladesh's current foreign exchange reserve stands at US$ 27.5 billion which is sufficient to meet more than seven months of import payment. However, the BB estimates export and import to grow by 8.5 per cent in FY16 and remittance to increase by 5 per cent for the next fiscal year. This will put pressure on the foreign exchange reserve. However, lower fuel import cost will benefit countries like ours. On the other hand, the number of people going abroad for jobs is rising and it is expected that the remittance will remain stable amid ongoing crisis in the Middle East. The BB projects current account balance to be US$ 955 million and BoP (balance of payments) to be US$ 2.28 billion in 2015-16.

Bangladesh's capital market, which has stabilised after 2010 bubble, has been dealt well by the SEC (Securities and Exchange Commission) and the BB for making it vibrant. The BB has devised ways to make the stock market operate in full swing even after the central bank reined in the exposure of commercial banks in the stock market to realign them to global standards. The BB has been directing the commercial banks to utilise their idle liquidity for helping farm and non-farm micro, small and medium enterprises (MSMEs).

Green projects have also been given the opportunity to get lower rates as the World Bank is committed to contribute US$ 300 million credit for various projects. The BB will also add another US$ 200 million to the fund making it a total of US$ 500 million. The US$ 300 million fund will be utilised for medium to long-term foreign currency financing of manufacturing projects. The BB's US$ 200 million fund will be specifically used to help greening initiatives of export-oriented textiles, apparel and leather sectors. The central bank will also extend low-cost fund for promoting woman entrepreneurship, skill building projects and energy expansion initiatives. The Export Development Fund (EDF) has been raised to US$ 2.0 billion to accommodate such 'selective easing' by the BB.

The writers are bankers. [email protected]

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