Monetary policy won’t work if interest rate cap stays

By retaining the interest rate cap on lending and fixed exchange rate, the upcoming monetary policy for the second half of this fiscal year will not play any role in containing inflation, economists said.

If Bangladesh Bank continues to maintain its stance, there will be no other option but to inject a large amount of money from its coffer into the government which will subsequently create price instability in the market, said economists.

The central bank will unveil its monetary policy statement for the January-June period today at a time when the economy is struggling to tackle inflation. The key targets of any monetary policy are usually set to diffuse the price pressure.

Inflation stood at 8.71 per cent in December last year, down 14 basis points from the month before, according to data from the Bangladesh Bureau of Statistics (BBS).

Inflation in the country had come down to 8.85 per cent last November after surging to a 10-year high of 9.52 per cent in August.

The government set an inflation target of 5.6 per cent for FY23 in its fiscal budget.

"Inflation is still higher, and there is a probability to stoke it further…," said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh.

If the central bank wants to control inflation, it will have to withdraw the 9 per cent cap on interest for lending, he said.

The banking sector has been following the cap since April 2020 as per the instruction of the central bank.

Although the central bank frequently claimed that it had imposed the cap to ensure smooth supply of credit to entrepreneurs, such a cap hardly plays any positive role in gearing up the economic activities, he said.

Macroeconomic stability is much more important than following a fixed interest rate cap, he said.

He said business associations, including the Federation of Bangladesh Chambers of Commerce and Industry, have compelled the central bank not to withdraw the interest rate cap.

If the commoners, including businesses, do not get a good return from banks, they will not bring their money to the country, said Mansur, also a former high official of the International Monetary Fund.

This ultimately creates pressure on the foreign exchange regime, which has been facing volatility since the second half of last fiscal year.

Remitters will feel encouraged to send more money to the country if they enjoy a better return from banks, he said.

"This is also applicable to the exporters. Some exporters may not repatriate their earnings to the country due to the lower interest rates offered by banks," he said.

In addition, many individuals and businesses now invest their funds in unproductive sectors, such as land and gold, as they are not getting their desired returns on keeping money in banks, Mansur said.

Zahid Hussain, a former lead economist of the World Bank's Dhaka office, said the central bank has been unable to independently draw up a monetary policy as it has to inject money rampantly to fulfill the government's wishes.

The monetary policy is now dominated by the fiscal policy since the central bank has to provide printed or high-powered money as per the government's wish, he said.

The central bank should be empowered to control government borrowing to implement an independent monetary policy, he added.

Between July 1 and December 29 this fiscal year, the government took Tk 66,000 crore in loans from the central bank.

On top of that, the government has so far injected around $8 billion into the market to help banks clear import bills.

The foreign exchange reserves of Bangladesh stood at $32.52 billion on January 11 in contrast to $44.92 billion on the same day a year ago.

The central bank should allow the market forces to determine the exchange rate of the taka against the dollar to restore discipline in the foreign exchange market, Hussain said.

If the issues are not addressed, the upcoming monetary policy will not be able to play an effective role in solving the ongoing problems in the financial sector, he said.