The central bank has hiked the key interest rate three times in four months, but inflation continues to spiral, putting additional strain on household budgets
Bangladesh Bank has raised its key policy rate three times in four months in desperation to rein in inflation by putting pressure on the cash flow. Instead, private-sector borrowing has increased as the cap on the interest rate has remained in place.
Now economists are questioning the rate hike while keeping the cap, as inflation continues to skyrocket, reports bdnew24.com.
Economist Ahsan Mansur thinks the central bank’s rate hike will not affect the flow of cash into the market as long as the cap of 9 per cent interest rate stays.
“Repo rate has been raised, but not the interest rate. Then how will this effort be effective?” asked Zahid Hussain, former lead economist at the World Bank’s Dhaka office.
Central banks can control the money supply of a country. If the money supply of a country is high, it can spur inflation. In such cases, banks can use a number of tools to reduce inflationary pressure and bring it under control.
One such method is to raise the key interest rate, also known as the repurchase agreement or overnight repo rate, to rein in the money supply. The repo rate is the rate at which the central bank lends money to commercial banks when there is any shortfall of funds. Raising the repo rate makes it more costly for commercial banks to borrow, making loans more expensive, and restricting the money supply.
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To ease the pressure of inflation, Bangladesh Bank, like the central banks of other countries, raised the repo rate on Sept 29, by 25 basis points to 5.75 percent, at which commercial banks can borrow from the central bank, for a period of one to 28 days.
An increase in the repo rate means banks have to pay more to borrow from the central bank, making the rate an instrument that allows the central bank to monitor and control the liquidity and investment in the market.
Before that, on Jun 30, Bangladesh Bank had hiked the repo rate by 50 basis points to 5.50 per cent.
In July, the month immediately following the repo rate hike, credit growth in the private sector was 13.95 per cent, the highest in the last 45 months, or nearly four years.
At the end of August, it increased even further to 14.07 per cent.
A similar trend had followed the central bank’s decision to raise the repo rate from 4.75 per cent to 5 per cent on May 29. June saw credit growth in the private sector at 13.95 per cent, up from 12.94 per cent in May.
As such, it is clear that, despite the changes to the repo rate, the money supply in the market could not be controlled.
At the end of June, Bangladesh Bank released its monetary policy plan for the current fiscal year. In that report, the target for private sector credit growth was 14.10 per cent.
Consumer prices fell to 7.48 per cent in July this year from a nine-year peak of 7.56 per cent in the previous month as credit continued to grow.
The government set an average inflation target of 5.6 per cent for this fiscal year.
But consumer prices in Bangladesh increased at the fastest rate in a decade with inflation surging to 9.5 per cent in August. In September, it fell slightly to 9.1 per cent.
WHY CREDIT IS GROWING
Economist Zahid Hussain says any central bank has another instrument to control inflation - the interest rate at which businesses borrow funds from the commercial banks.
"Bangladesh Bank has not changed the 9 per cent cap on loan interest rate. If it is raised a bit, to a maximum of 12 or 15 per cent, the cost of borrowing for businesses will increase. They will then attempt to reduce costs and this would have controlled inflation,” Zahid explained.
Instead, Bangladesh Bank’s policies are giving money to businesses at a low cost, he said. If the loan interest rate does not increase alongside the repo rate, it will not be effective at controlling credit or inflation.
Will repo rate hikes help tame inflation in Bangladesh? Economists have doubts
Zahid said that the central bank could also step in to reduce the money supply directly in an effort to control inflation. If Bangladesh Bank sold treasury bills and bonds on the market, it could remove money from the market and cut down the total supply.
Other measures to control cash flow, inflation:
For the past 15 months, Bangladesh Bank has controlled the money supply by selling dollars on the market to regulate inflation, Zahid said. In the past fiscal year, it removed nearly Tk 8 billion from the market in this way.
This is why the money supply in the market has fluctuated, he said.
Zahid Hussain said the government’s initiative in the current budget to adjust demand and supply to maintain a steady supply of products to the market and reduce costs was a logical one, but the effectiveness of its implementation was not yet clear.
The government has also taken several steps to try and limit rising costs.
Austerity initiatives were notable in this year’s national budget.
It suspended work or delayed the release of funds on projects that weren’t essential to public welfare.
Public offices were opened at 8:00am – two hours early – to make use of sunlight and cut down on electricity.
It also halted purchases of cars and ordered 20 per cent of fuel to be reserved. The government also cut customs duties for cooking oil and rice.
But, like the increase of the repo rate, none of these measures have managed to calm inflationary pressure. And families are struggling.
