BB hikes key interest rate by 25 basis points

Move may not curb inflation as loans still cheaper, say economists

The Bangladesh Bank yesterday raised its benchmark interest rate by 25 basis points to 5.75 per cent as it stepped up its fight against inflation, which is running at a multi-year high.  

This was the third hike since May 29, an unprecedented move on the part of the BB as it has never revised the rate upwards multiple times in such a short time.

The move is in line with the efforts of central banks around the globe as they are desperately trying to curb inflationary pressures amid supply chain disruption, driven by the Russia-Ukraine war.

For example, the Federal Reserve of the US, the central bank of the US, hiked interest rates in September for the fifth consecutive time. Similarly, the European Central Bank raised interest rates in July and September.

The UK raised the rate recently, while India's central bank is expected to increase its policy rate by half a point for the third time in a row.

But it remains to be seen whether the BB's intervention, which is meant to be making funds costlier for borrowers, would be able to contain inflation since loans are relatively cheaper in Bangladesh at the moment owing to a ceiling on interest rates.

The central bank has maintained the lending interest rate cap of 9 per cent since April 2020.

Usually, central banks raise interest rates to curb accelerating inflation and safeguard price stability.

A higher interest rate pushes up the lower limit for lending rates to firms and households, disincentivising their consumption and investment. In turn, this reduces aggregate demand in the economy, thus lowering inflationary pressures, according to the Asian Development Bank (ADB).

The policy rate, which is termed the repurchase agreement (repo) in Bangladesh, is a pivotal benchmark interest rate that commercial banks follow in fixing the interest rates on both loans and deposits.

Quoting the rate, cash-strapped banks take short-term loans from the BB and disburse them among borrowers.

Md Habibur Rahman, chief economist of the BB, says that inflation may go up further in the days to come, prompting the central bank to raise the policy rate once again.

In July, inflation fell to 7.48 per cent from a nine-year high of 7.56 per cent in June. The government has not published the figure for August.

In addition, the private sector credit growth is now on the increase, an indication of the upward trend of the money supply.

Private sector credit growth surged to 14.07 per cent in August, almost touching the central bank's target for the entire fiscal year of 14.1 per cent.

The rising private sector credit growth means the central bank's monetary policy stance is not bringing about desired outcomes. 

"The policy rate hike means the central bank is now stricter in reducing the supply of money than before," said Rahman.

Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, said the demand for loans would not go down until the interest cap on loans is withdrawn.

"If interest rate cap is lifted, lending will decrease across the board and this will ultimately squeeze the money supply."

The economist said money supply from the central bank through the repo platform will not face any major barrier as banks will continue to lend to businesses at the current pace.

"So, the latest central bank initiative will not help the economy contain inflation," he said, adding that cash-strapped banks will, however, see their profit decline.

A number of BB officials, on the condition of anonymity, said that the withdrawal of the lending rate cap was discussed at a BB meeting yesterday.

"But it is not possible for the central bank to take any move to this end since the cap is being implemented at the instruction of the government," said one of them.

A managing director of a bank alleged that a group of influential borrowers is compelling both the government and the central bank to follow the cap so as to borrow at cheaper rates.

Selim Raihan, executive director of the South Asian Network on Economic Modeling, said that revising the policy rate upward would not help arrest inflation.

"If the central bank can't withdraw the cap, it should at least relax the ceiling in the interest of the economy."

Monzur Hossain, research director of the Bangladesh Institute of Development Studies, thinks raising the policy rate may slow down the private sector credit growth, but says it will not bring any major positive impact when it comes to fighting inflation.

"Now is the time to consider withdrawing the lending interest cap."

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, says banks will be in a disadvantaged situation as their cost of borrowing from the central bank would go up. "But the private sector credit growth is not likely to dip."

Another BB official says if the interest rate ceiling is scrapped, the money supply will decrease, which will subsequently reduce the demand for goods and services.

"This will help curb imports."

Bangladesh's foreign exchange reserves have been hit hard by the escalation of import payments.

The reserves stood at $36.44 billion yesterday in contrast to $46.28 billion a year ago.

According to the ADB, many central banks in the region have already raised policy rates, but it is likely that more tightening will be needed.

For now, real interest rates are low or even negative in much of the region, despite rising inflation expectations.

Going forward, the Manila-based lender said, central banks facing persistent pressures of currency depreciation may opt for a more aggressive hiking cycle, as well as the careful implementation of appropriate capital flow management policies to deal with potentially destabilising and unwanted capital outflows.

The taka has lost its value by about 25 per cent against the US dollar in the past one year amid shortages of the American greenback. 


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