IMF for keeping policy rate at 10% to contain inflation

Bangladesh should maintain its policy rate at 10 percent until the middle of fiscal year 2025-26, the International Monetary Fund (IMF) has said, citing the inflationary pressures of a weaker currency and the heightened sensitivity of inflation expectations to exchange rate depreciation.

It said the uncertainty surrounding inflation, external imbalances, and forex market pressures calls for a cautious approach to unwinding the tighter monetary policy stance and for a higher degree of exchange rate flexibility.

"Normalising inflation to the target range will become more protracted if the Taka depreciates in response to the impact of US tariffs on the external trade balance," it said.

The Fund made the observation in its report following the third and fourth reviews of the conditions it had attached to the $5.5 billion ongoing loan package for Bangladesh to help restore macro-economic stability.

The Bangladesh Bank (BB) raised the policy or repo rate, at which BB lends to commercial banks, in October last year to 10 percent.

In BB's effort to contain runaway inflation, which remained above 9 percent for more than two years until May, the rate hike was the 11th time since May 2022.

The BB maintained the policy rate unchanged for the January-June period of this year as inflation stayed high.

In the three months to June, consumer prices eased to 8.48 percent from 9.05 percent the previous month, according to the Bangladesh Bureau of Statistics (BBS).

The annual average inflation, however, stood at over 10 percent, higher than the BB's expectation of 7-8 percent at the end of June.

In an interview with The Daily Star early this month, BB Governor Ahsan H Mansur said the policy rate is likely to remain unchanged in the monetary policy for July-December of FY26.

The monetary policy is expected to be unveiled at the end of July.

The IMF said monetary policy should remain data-driven, and the BB should cautiously commence the easing cycle based on solid evidence that current and projected inflation is declining to the target range of 5-6 percent.

"For effective policy transmission, it is critical that retail interest rates continue to be set freely by banks, based on risk-return considerations, and that BB avoids unsterilised liquidity injections into weak banks that lead to excessive softening of government debt yields and, potentially, of broader financing conditions."

The multilateral lender, referring to the relaunch of the market-based exchange rate regime in May this year, said the BB should stand ready to tighten monetary policy to increase the interest rate differential if significant overshooting of the exchange rate occurs amid shallow forex liquidity.

"Comprehensive and continuous implementation of the new exchange rate regime remains a crucial transitional step towards full exchange rate flexibility," said the IMF report released by the end of last month.

"It is essential for facilitating smooth external adjustment, preserving foreign reserves, and improving the functioning and liquidity of the FX market."

The IMF said exchange rate parameters should be set based on macro-fundamentals relative to a basket of currencies, with a daily operational exchange rate band set against the US dollar.

"Banks should be permitted to quote freely in the FX market to facilitate a market-based exchange rate. To achieve this, BB must refrain from moral suasion of banks and avoid regulatory measures that restrict free quoting."

The Fund said forex interventions must be auction-based. "A transaction-based reference exchange rate for client and interbank markets needs to be published continuously."

The report said steady progress in modernising the monetary policy framework remains critical to ensure the transition to a forward-looking monetary policy.

"A two-staged transition to a fully flexible exchange rate system and an interest-rate-based flexible inflation targeting framework is a priority," it added.