Will the MPS be able to achieve its objectives?

Illustration: TBS

The Monetary Policy Statement (MPS) of H124 by Bangladesh Bank (BB) aims to contain inflation by reducing aggregate demand, continuing supply-side interventions, ensuring a flow of funds to productive sectors, and supporting import-substitute sectors. It emphasises the urgent need for a stable and favourable business environment, investment growth, and increasing credit flow.

As a strategy, it has taken a contractionary monetary policy stance, accompanied by specific policy initiatives. New tools introduced in the MPS are the Standing Lending Facility (SLF) rate, Standing Deposit Facility (SDF) rate, interest rate corridor and Six-Month Moving Average Rate of Treasury Bill (SMART). 

Gross International Reserve (GIR) will now be prepared as per BPM6 (balance of payment and international investment position manual) of IMF for calculating and reporting total foreign assets. 

Interest Rate Corridor (IRC) has been announced as one of the tools, referring to the range of interest rates set by the Bangladesh Bank (BB) to manage liquidity and steer market interest rates. It consists of two key rates: SLF or ceiling rate which will be 8.50% and SDF will be 4.5%. The main target is to set a ceiling to stop market volatility. The targeted policy rate will be changed to 6.50% from 6.0%. 

In the revised framework, the policy rate will replace the overnight repo rate, the ceiling of SLF will replace the special repo rate, and the floor rate or SDF will replace the reverse repo rate. The difference between SDF and SLF is the spread, which is 4% now. These are the instruments for interbank loans and borrowing from BB.

The reference rate for fixing the interest rate will be SMART plus 3% for banks and SMART plus 5% for NBFI, and an additional 1% for CMSME and consumer loans. The monthly SMART rate will be announced through the BB website regularly. Considering the Treasury Bill rate at 7.10% (in July 2023) plus 3% will mean that the interest rate will be around 10.10% for Banks and 12.10% for NBFIs.

Bangladesh Bank will also adopt a unified and market-driven single exchange rate regime between BDT and USD, which is presently about four and three official rates and one curb market rate, which fluctuates depending on supply and demand.

Experts believe that inflation is linked to many factors such as the state of the economy, the credibility and independence of the central bank, and the confidence of businesses in the business-enabling ecosystem. 

The IRC is a system for guiding interest rates of short-term markets towards the BB target/policy rate. It consists of the rate at which the BB lends to banks (typically an overnight lending rate) and the rate at which it takes deposits from them (deposit rate). IRC is the minimum and maximum interest rate callers.

As per a recent discussion in the dialogue at BUILD, in a standard corridor, the lending rate will be above the policy rate (thereby forming an upper bound for short-term market rates), and the deposit rate will be below the policy rate, thereby forming the lower bound. 

The rate on the deposit facility and the rate on the marginal lending facility defines a floor and a ceiling for the overnight interest rate at which banks lend to each other. This creates an interest rate corridor for money markets. By varying liquidity in the system, the central bank can aim to keep actual rates close to the policy rate.

Historically, countries like Canada, Turkey, Nepal, India and Sri Lanka have implemented IRC systems. Bangladesh recently transitioned from a 'monetary' targeting framework to an 'interest rate' targeting framework, introducing a policy rate of 6.50% with a corridor of ±200 basis points, aiming to stabilise the interbank call money rate. 

IRC will provide clear policy signals to market participants, which aids in monetary policy transmission; however, there are several factors to consider, such as government incentives, loan tenure, structural bottlenecks, inflation control, and the role market players may play in distorting prices.

The effectiveness of IRC in controlling inflation will be questionable, especially when fiscal measures are expansionary, and government borrowing affects inflation. The fiscal year 2023-24 budget has a considerable deficit of about BDT 2.82 trillion, of which about BDT 1.21 trillion will come from banks. 

Government borrowing is a concern, and there are different sources of government borrowing. One is from commercial banks through treasury bills and bonds, and another is to borrow from the central bank. The government can borrow up to a certain amount for wages and means. 

Another source of borrowing is printing money from the central bank. If the printing money is not utilised properly in the productive sector, it will pose a problem. Bangladesh yearns for growth targeted at 7.5% and inflation at  6%.

BB has opted for market-driven interest rates. We have many parameters that are not market-driven. Apart from that, we are expecting SMART to be market-driven. We need first to understand and analyse the reasons why inflation is not being contained, this will make finding the remedy easier. 

We can follow the examples of other countries to contain inflation using monetary policy tools. In India, the inflation was 6.76% in June 2022 and reduced to 4.81% in June 2023. Even inflation in Sri Lanka decreased to 12% in June 2023 from 25.2% in May 2023. 

In the dialogue, BUILD experts discussed whether the treasury rate is market-driven, while GIR calculation will be based on an IMF-prescribed formula. As the interest rate is linked with treasury bills and not fully driven by the market rate, BB can maintain a market-based rate to contain inflation. MPS did not give any directives or any change to the incentive package of special fund loans and credit cards. It also did not provide any specific measures in preparing to address the governance issues. 

The MPS desired to establish a uniform exchange rate to stabilize demand and supply. BB's Export Development Fund (EDF) was supposed to help exporters, which has now gradually been reduced and substituted by EFPF. Another source of money supply is the Return on Investment (ROI). The ROI of the SME sector is much less than large industries. Several NPLs are in existence in the market. So, the shortage of money supply increases gradually. 

Banks' deposit rate is also declining as governance-related issues are coming up, affecting confidence in the financial system. If this situation continues, maintaining the liquidity ratio will be a challenge for the banks. 

Access to finance to CMSMEs will be difficult as the supply side of businesses will be affected, and consumers too will face the impact of the introduction of the new MPS model. Multinationals are trying to minimise its impact by handling vendors and suppliers efficiently. They are trying to expand the export business and attract foreign investment by shifting their sourcing from imports to the local market. The uniform exchange rate will be helpful if it exists. 

There has been a gradual increase in digital money and money transfer. BB has lost control of different variables (export, import, interest rate, government debt and market) as demand for money has become unstable. 

The business community was in favour of reducing the interest rate for some time. The recent scenario shows that the credit taken from foreign sources has become more expensive, whereas the SMART plus rate is better. If the market-based rate sets the interest rate, it is more manageable than the interest cap mechanism. 

So far, MPS has not given a SMART rate for deposits, and the banks and FI themselves will manage it. Primary Dealers have a significant role to play in ensuring liquidity requirements.

As the interest rate is linked with Treasury Bills and not entirely driven by the market rate, how BB will maintain a market-based rate and IRC will contain inflation as a tool, would need to be monitored closely. Monetary Policy should be aligned with fiscal policy. Budget deficit must be kept in mind while setting different targets and before introducing a new MPS.

The cost of doing business should be reduced. The government could have filtered some projects to save us and reduce external pressures. Infrastructure and private sector development are interrelated; without public sector development, private sector investment and growth will pause.

We would like to continue with near double-digit economic growth. The 8th five-year plan has set an ambitious target. But several global challenges after Covid-19 have affected our growth targets. MPS has announced some policy tools following the examples of other countries. However, close monitoring is needed to observe if it can achieve its broader objectives and give confidence to businesses. There are stringent and challenging technical issues that are beyond the understanding of the common people. Policy-level circulars and concerned stakeholders consultations can gradually bring transparency.

Ferdaus Ara Begum is the CEO of BUILD-a Public Private Dialogue Platform that works for private sector development.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.