Most international organisations, which carry out periodic macroeconomic analysis on Bangladesh, are fairly optimistic about the country's growth prospects this year. The general consensus is that increased public sector investment in infrastructure development, government employees' wage hike and steady export performance will drive growth beyond 6.5 per cent. This would certainly be a commendable achievement by any standard of measure. Assuming political stability prevails, only one major factor is holding back GDP growth from surpassing the transformative 7 per cent figure: private sector investment. We all know that high bank lending rate is one important factor hindering investment. From this standpoint, it is not difficult to conclude that the central bank should ease policy rates (as suggested by a leading think-tank recently) to lower banking sector's cost of fund. This would facilitate lower lending rates.
However, in an environment of rising non-food (core) inflation, prevailing excess liquidity in banks and doubts related to the efficiency of policy rate transmission to the real economy, lowering of the repo and reverse repo rates does not appear to be the optimal strategy to boost investment. Some might argue for an increase in reserve money growth - Bangladesh Bank's (BB) intermediate monetary target. But, simply raising target for reserve money growth will not necessarily stimulate investment. What measures can BB undertake to reduce cost of fund for banks to lower lending rates?
One way is to lower Cash Reserve Ratio (CRR). CRR is the percentage of total deposits a bank is required to hold as reserves with BB. Since banks do not receive any compensation on such reserves, lowering of this regulatory requirement will reduce cost for banks as they can invest the money in profitable ventures immediately. With a lag, reduction in CRR and the associated reduction in cost of fund should be passed on to final consumers through lower lending rates. However, given massive amounts of excess liquidity already floating in the banking sector, utilising this instrument will only serve to raise inflationary risks similar to policy rate easing. In the light of this threat, utilising CRR is not the optimal call. Clearly BB is in a tricky situation: it must devise monetary policy to stimulate private sector investment, but 'conventional' instruments such as policy rate or CRR can do more harm than good when it comes to containing inflation.
Given these constraints, what can BB do? We believe any monetary easing strategy has to be highly guided and selective. It is encouraging to note that BB is already quite active in such measures. The authorities have undertaken a 'Selective Easing' process where monetary accommodation is provided at lower interest rates in selected productive pursuits. Under this programme, loans are extended to productive and vulnerable sectors at affordable rates. Projects under this programme include green initiatives, export promotion activities, environmentally responsible investments, women entrepreneurship, skill-building ventures, energy expansion etc. BB has also worked with the World Bank to formulate a medium to long-term foreign currency fund aimed at promoting manufacturing sector projects. On top of that, the export development fund has been increased from only US$ 100 million in 2006 to US$ 2.0 billion in 2015. These initiatives are highly commendable and certainly consistent with BB's objective of implementing an inclusive growth-augmenting policy. As such, selective easing appears to be BB's best option to reduce cost of fund and stimulate private sector investment.
However, given tremendous demand for low-cost capital, we need to ask whether existing amount of financial resource that is allocated in such programmes is sufficient to catalyze private sector credit and investment. For example, the Export Development Fund - despite being increased - is still only 6 per cent of Bangladesh's total exports. To get an approximate idea of demand for credit from private sector, we look at monthly change in private sector credit for the last 12 months using data from Bangladesh Bank. We also look at the overall change in private sector credit (absolute value) from November 2014 to November 2015. While there were fluctuations, it can be argued that private sector credit has generally increased by more than US$ 500 million on a monthly basis for the last one year. Based on this amount, it does not appear that capital allocated in Selective Easing programmes is adequate enough to exert sizeable influence on private sector credit growth and break the '6-per cent growth trap'.
In this context, it is absolutely essential that authorities utilise its burgeoning volume of foreign exchange (forex) reserves to expand selective easing. At US$ 27.5 billion, forex reserves can now finance more than seven months of imports. Here lies the need for a more dynamic reserve management strategy where foreign exchange in excess of a certain agreed threshold should be directed towards more productive pursuits. For instance, forex reserves in excess of six months of import cover can be allocated towards selective easing programmes. Such strategies can mobilise US$ 3-4 billion, which the authorities could use to set up a dedicated low-cost foreign currency fund aimed specifically at manufacturing enterprises to accelerate productive imports.
There are three distinct benefits of utilising reserves in this manner. (i) BB can positively impact greater share of the economy by making higher amount of funds available at lower interest rates, (ii) Despite supplying fund at low interest rates, BB can earn substantially higher return on forex reserves compared to 0.5-1.0 per cent that it currently receives by investing in foreign government securities, (iii) If BB successfully expands its selective easing programme and directs low-cost foreign reserves towards manufacturing sector projects, we can expect to see a marked improvement in productive imports (naturally with a lag). Accelerated imports will reduce pace of foreign currency inflow reducing the need to intervene in the foreign exchange market. It will also open up a more realistic window of opportunity to depreciate the exchange rate - a growing demand of exporters.
With regard to BB's monetary targets (Broad Money, Net Domestic Asset, Private Sector Credit, Public Sector Credit etc), certain modifications are necessary given recent macro development and expected outlook. For instance, current monetary policy targets credit growth to private sector and public sector of 15.0 and 23.7 per cent respectively. As the chart below shows, credit to private sector has started to pick up only in the last 3 months after remaining largely stagnant at around 12 per cent between Fiscal Year (FY) 13 and FY 15. From 12.69 per cent in August 2015, credit growth to private sector has risen to 13.7 per cent in November. This is mostly attributable to gradual reduction in bank lending rates. Assuming political stability continues, credit growth is expected to rise in coming months. The authorities should consider slightly raising of its target of credit to the private sector by around 20-50 basis points. This view is consistent with an expanded Selective Easing programme outlined above, aimed at promoting private sector investment.
Simultaneously, the authorities will have to seriously reconsider its target of credit to public sector. From July to November, growth in 'net credit to government sector' and 'credit to other public sector' were both negative compared to BB's 23.7 per cent target. Substantial reduction is necessary in this monetary target given continuous sale of national savings scheme which has reduced the government's need to borrow from BB. If these two changes (small increase in private sector credit growth and relatively larger decrease in public sector credit growth) are properly calibrated, it is possible to keep reserve money growth at existing target (recognising that the share of private sector credit is much higher than public sector credit in total domestic credit).
Before concluding, it is worth mentioning that the monetary policy stance has strengthened substantially in recent years and authorities should be highly praised for their initiatives. A simple comparison of monetary management between FY 10-12 and thereafter makes that clear. Following excessively high money supply growth which pushed up inflation, land and stock prices to exorbitant levels, BB's cautious monetary policy for the last three years has helped to restore financial sector stability and keep inflation within a tolerable limit. While monetary policy should largely maintain its current course, there is an urgent need to step up selective easing initiatives. The authorities already have the resources - US$ 27.5 billion and counting. The question is: will they use it?
(Concluded)
The writer currently works as a Macroeconomic Analyst for an organization in Washington D.C. He is a Fellow for the Asian Centre for Development in Dhaka. Â
 shaque4@jhu.edu