Rationale for cash reserve hike

Atiur Rahman

The central bank's latest step to raise the cash reserve ratio for banks will not be very popular in the private sector, but was necessary -- to contain inflation. These were the words from Bangladesh Bank Governor Atiur Rahman.
In an interview with The Daily Star, the BB chief said: "The private sector will raise a hue and cry, but we cannot take risks. The cash reserve ratio has been increased to contain inflation."
With the new directive out yesterday, CRR (cash reserve ratio) rose by 0.5 percentage point to 5.5 percent.
"The private sector credit has increased to some extent -- it has overheated. That's why the step was taken."
Rahman said measures would be taken so that the flow of credit to the productive sector does not fall. "We will continue to push the productive sector. Steps will be taken to ensure that productive sectors, such as exports, agriculture and SMEs, get sufficient loans."
"Though inflation in Bangladesh increased slightly in recent times, we are fortunately in a better situation than our neighbours. The inflation rate in Bangladesh is lower than in India and Pakistan," he said.
On a point-to-point basis, the rate of inflation is a bit high now. But on average, the inflation rate will remain within the target of 6.5 percent, Rahman added.
The point-to-point basis inflation rate increased due to an increase in food prices, which will drop with boro crop harvests, he said.
Rahman said they are not sitting idle even for a minute. They are reviewing the monetary policy on a regular basis, he added.
According to the governor, the central bank is running the monetary policy in a practical manner and monetary instruments, like Repo and reverse Repo, have always been used to keep inflation under check.
The Repo rate is the interest rate at which Bangladesh Bank lends money to other banks. The reverse Repo rate is return banks earn on excess funds parked with the central bank against government securities.
The reserve requirement is a central bank regulation that sets the minimum reserves each bank must hold against customer deposits. The reserve ratio is sometimes used as a tool in the monetary policy, influencing the country's economy, borrowing and interest rates.
Economists and businessmen think the new step will make the businessmen's access to bank finance difficult. It will also sag the investment that has shown signs of a pickup.
Rahman also said presently, there is no zero rate of interest in the economy. He said whatever excess liquidity exists, it is with the Islami banks as they cannot invest on the basis of interest.
Even then, inflation is rising because of a price hike in the international market and for that, the macroeconomic instrument like CRR has slightly increased, the governor said. The instrument in used as part of demand management to curb inflation.
In response to a query on the static foreign exchange rate, the BB governor said the market determines the exchange rate and the central bank does not interfere. He said sometimes BB plays the role of a player, so that the market does not become volatile.
Rahman said if BB did not partake the role, the exchange rate would have dropped further, which would have adversely affected exporters.
The government has been taking steps to set up rental power plant for quick generation of electricity. Rahman said it would have some pressure on the foreign exchange reserve but it will not be so intense that a vulnerable situation is created.
The BB governor said the pressure is a temporary phenomena and the central bank has the power to absorb the pressure. He said providing electricity was the government's electoral commitment and so, it has to take measures to fulfill it.
In addition, along with taking short-term projects of costly rental power plants, several innovative initiatives to generate power in the mainstream are also underway. "An initiative has been taken to form an energy fund, with which, large power plants will be set up."
In the case of power, the government's biggest challenge is fixing the price, the governor added. "If prices cannot be increased, the government will have to count huge subsidies, which is a budgetary challenge."
Rahman however said the government has taken up the challenge with courage. In this case, the government is not borrowing from the banking system, rather facing the pressure by increasing government revenue earning and foreign assistance, he explained.
He said the government borrowing had no inflationary impacts.