Monetary policy for FY23: Key tools not there to rein in inflation

Bangladesh Bank yesterday attached the highest importance to curbing inflation in its monetary policy for fiscal 2022-23 but didn’t deploy major tools needed to ride out the current economic challenges.

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Though the BB hiked the policy rate by 50 basis points to 5.50 percent yesterday to reduce the money supply to the market, it didn’t lift the lending rate cap.

Economists say the measure will not be effective enough to contain inflation.

They have long been suggesting that the central bank withdraw the lending rate cap of 9 percent or make it flexible to check inflation and restore stability in the foreign exchange market.

BB Governor Fazle Kabir unveiled the monetary policy statement at the central bank headquarters in the capital.

“We will give all-out efforts to contain inflation and keep the foreign exchange reserves stable. The central bank will then give attention to GDP growth,” he said.

Driven by a hike in food costs, inflation surged to an eight-year high of 7.42 percent in May.

Inflation averaged 5.99 percent between July last year and May this year against the government target of 5.7 percent.

The government has set an inflation target of 5.6 percent for FY23 starting today.

Economists say the increase in the policy rate is definitely good, but the economy will not reap the benefit immediately from the monetary policy.

The policy rate has been hiked twice within a month for the first time since its introduction in 2003. The BB raised it by 25 basis points on May 29 this year and by 50 basis points yesterday.

The policy rate is a pivotal benchmark interest rate that commercial banks follow for fixing interest rates on both loans and deposits. An increase in the rate makes loans more costly.

Quoting the policy rate, cash-strapped banks take short-term loans from the BB and disburse those to individual borrowers.

Talking to The Daily Star, Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, said the monetary programmes will not help contain inflation immediately for the absence of effective tools.

The increase in the policy rate will create liquidity pressure in the banking sector but it will take time to slow down the money supply, he pointed out.

Had the BB withdrawn the lending rate cap or made it flexible, inflation could have been managed efficiently within the quickest possible time, Ahsan said.

The BB has set a lower private sector credit growth target of 14.1 percent for FY23, compared to 14.80 percent in FY22.

As per the BB projection, the credit growth will be at 13.1 percent in the last fiscal year.

Md Habibur Rahman, chief economist of the central bank, said, “The central bank set a lower credit growth target to reduce the supply of money to the market.”

Fazle Kabir said the global economy is now facing an uncertainty due to the ongoing Russia-Ukraine war, prompting the International Monetary Fund to cut the global growth projection.

The prices of major commodities, including petroleum, have been on the rise in the global market due to the war, he said.

Amid such a situation, the country’s import payment has shot up in recent months.

Between July and April in FY22, imports went up by 41 percent to $68.66 billion, bringing the reserves down to $41.7 billion on June 28. The figure was $46.15 billion on December 31 last year.

The BB governor said, “The major challenge of the monetary policy is to contain inflation and keep the exchange rate stable.”

The exchange rate of the taka stood at Tk 93.45 a dollar yesterday compared to Tk 84.80 a year ago.

Ahsan said that if the lending rate cap is withdrawn, the interest rate on import financing, now a maximum of 9 percent, will go up substantially, and this will help bring stability to the foreign exchange market.

He further said the latest monetary policy will not bring any good to depositors as inflation continues to rise,.

Zahid Hussain, former lead economist at the World Bank’s Dhaka office, said the BB termed the monetary policy for FY23 “tight” and “cautious”.

“The tightness can be found only in the increase in the policy rate by 50 basis points.”

Zahid said some of the measures announced in the policy are, in fact, likely to be inflationary.

“Further increases in LC [letter of credit] margins on non-essential imports will push up prices even if they are effective in reducing the demand for foreign exchange.”

He said the monetary policy includes some expansionary measures such as new refinance scheme to boost production of import-substituting products and continued support for stimulus packages.

Monzur Hossain, research director at Bangladesh Institute of Development Studies, said the monetary policy appeared to be cautionary and slightly contractionary.

However, the increase in policy rate will not help contain inflation as the lending rate cap remains unchanged, he pointed out.

“The big challenge for the policy is that the monetary instruments would not be effective if the government controls interest rates, ignoring the spirit of the interest rate deregulations.”

This means the monetary policy’s role in controlling inflation and stabilising volatile exchange rates would be limited, he said.

Fahmida Khatun, executive director at the Centre for Policy Dialogue, said it’s fine that the BB reduced the credit growth target in private sector to contain inflation.

“It’s an unusually stressful year. It’s not expected that private investment will rise at a high rate,” she said.

But the market will not function properly since the interest rate on lending has not been changed, she said.

“Interest rate should automatically adjust with supply and demand for funds in the market. In its absence, the whole mechanism will not function properly,” she added.

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