Central Bank’s stringent contractionary measures: How far is the waypoint?

AMIR MOHAMMED KHOSRU: Bangladesh is going through a hard inflation rate. Food inflation in the country has been above 12 percent for three months. According to the report from Bangladesh Bureau of Statistics (BBS), food price inflation was 12.56 percent in October, the highest in the last 11 years and 9 months. This inflation means in August 2022, the price of food products in rural areas was Taka 100, but in August of this year, it has become Taka 112 and 71 paisa. The Bangladesh Bank has taken various measures to address this inflationary trend over time. Recently, the Bangladesh Bank implemented contractionary monetary policies to limit the influx of money into the economy and curb inflation.

But my observation is will only this contractionary policy be effective to curb the inflation when this country is facing multifaceted financial challenges within the macroeconomic sector. Factors such as the rise in the price of the dollar, increased default loans in banks, a reduction in the lending capacity of banks, and the direct impact of money laundering and syndicate traders have collectively contributed to the prevailing inflationary pressures. In light of these complex challenges, it remains to be seen whether the implemented contractionary policies will prove adequate in effectively curbing inflation.

Recently as a part of contractionary policy, Bangladesh Bank has increased the Repo rate. This rate is crucial in influencing the borrowing behavior of commercial banks. Whopping 0.50 percent of interest rate has been increased that will result in a shift in the policy interest rate from 7.25 percent to 7.75 percent. By raising the policy interest rate, the central bank aims to deter commercial banks from borrowing, thereby restricting the influx of liquidity into the financial system. As a result, commercial banks will have to count additional interest rate against borrowing money from the central bank. This will be as deterrent for the commercial bank to borrow money that ultimately will shrink cash flown in the economy.

Besides, the central bank, also as a part of contractionary policy, has increased the Reverse Repo rate (now referred to as the Standing Deposit Facility or SDF) to incentivize the withdrawal of money from the market. Commercial banks will be paid an interest rate by the central bank to remove excess funds. The lower limit interest rate for reverse repo also rose by 50 basis points, moving from 5.25 percent to 5.75 percent.

Bangladesh Bank also showed stern mentality to constrain inflation while revising interest rate of Special Repo. Distressed banks borrow money from the central bank at a high Special Repo rate. The central bank gives loan to the distressed bank under Special Repo or SLF (Standing Lending Facility). BB has increased SLF rate for 50 basis points hike, escalating from the existing 9.25 percent to 9.75 percent.

The maximum allowable interest rate for bank loans has also been set at 11.18 percent, indicating a notable increase. This adjustment renders bank loans costlier for borrowers. Concurrently, the interest rate on smart loans, or the six-month moving average of treasury bills, has seen a 25 basis points rise, bringing the smart rate to 7.43 percent. Banks were initially permitted to add up to 3.5 percent interest to this rate, but with the latest decision, they can now add up to 3.75 percent. Consequently, under the new decision, the maximum interest rate on bank loans has been established at 11.18 percent.

We express our support for the recent decision made by the central bank. In a general sense, inflation is characterized by an increase in the purchasing power of buyers rather than a shortage of goods in the market. Consequently, central banks adopt a contractionary policy to diminish the flow of money, control the purchasing power of the public, and prevent inflation. Although this contractionary policy typically yields results over the long term, the current inflationary situation in Bangladesh is not solely a consequence of an excess flow of money in the hands of buyers.

Due to constraints in reserves, the price of the dollar has risen. Our country relies heavily on imports. When the process of regularly opening letters of credit encounters challenges, the prices of imported items increase, ultimately impacting the economic landscape and leading to inflation.

A majority of banks are currently grappling with operational challenges stemming from a liquidity crisis, primarily driven by a dwindling trust among customers in certain banks. The call money market has been under significant strain since the middle of 2022, with an increasing number of banks seeking liquidity support from the central bank. Consequently, the liquidity crunch has curtailed the banks’ lending capacity, resulting in a decline in new investment opportunities and employment prospects. This, in turn, has adversely affected economic growth, leading to inflationary pressures. The current inflationary trend can also be attributed to the escalating issue of non-performing loans.

Central bank data reveals that the total amount of bad loans in commercial banks has reached Tk 1,56,039 crore. Due to default loan, the flow of credit to industrial and SME sectors is constricting, causing capable borrowers to face difficulties in securing loans. Entrepreneurs and farmers are finding it challenging to access the necessary funds from banks, hampering production due to a lack of funds, leading to higher consumer prices and contributing to inflation.

Economists and market observers assert that the primary driver behind the inflation of various commodities, including food, is the existence of syndicates. They contend that influential groups have established distinct syndicates for each product in the market. Seizing opportunities, these entities exploit various pretexts to disrupt the markets of different products, and the government’s attempts to control these activities have repeatedly fallen short. Commerce Minister Dipu Munshi has already acknowledged the existence of these syndicates, emphasizing the need for the government to take stringent measures against them to effectively curb inflation.

The country is experiencing an alarming level of money laundering, with a significant portion of illicit funds being converted into foreign currency and smuggled abroad. This trend puts considerable pressure on the country’s foreign exchange reserves. Money laundering is done through manipulation and hundi practices in international trade, including import and export. Global Financial Integrity reports that, on average, Tk 64,000 crore is illicitly funneled abroad from Bangladesh each year under the guise of international trade. Between 2016 and 2020, Tk 320,000 crore was trafficked with Tk 98,000 crore trafficked out in 2015 alone. The impact of this laundered money on the national economy directly contributes to inflation, posing a significant challenge that needs to be addressed.

In light of these complex challenges, the central bank’s decision to address the inflationary situation is commendable. However, a comprehensive and collaborative effort involving government agencies, financial institutions, and regulatory bodies is imperative to tackle the root causes and establish a sustainable solution. The resilience and determination to confront these issues head-on will be crucial for steering Bangladesh towards economic stability and mitigating the adverse effects of inflation on the nation’s prosperity.

The author is a banker and columnist. Views are his personal. Zoombangla holds no responsibility for it.