Foggy stance of Bangladesh Bank on exchange rate

A key objective of issuing a monetary policy statement on the eve of the new fiscal year is to provide forward guidance to the public about the likely future course of monetary policy. When credible, individuals and businesses use this information in making decisions about spending and investments.

The operative word is credibility which the MPS falls short of in its diagnosis of the state of the economy.

The diagnosis of inflation attributes it to the surge in international prices.

The diagnosis of growth recovery attributes it to "recent surge in domestic demand" in addition to improvements in the Covid-19 situation, as if growth and inflation move independently of each other where demand only affects growth while international prices only affect inflation. This is hard to reconcile with a key time-tested lesson from Economics 101: when both price and volume are rising, it must be the case that demand played a key role in shaping the movement of both variables.

The MPS rightly highlights all sorts of factors that are likely to push inflation further in FY23. Yet it projects a decline in inflation to 5.6 per cent while growth is projected to increase to 7.5 per cent in FY23. How will these be possible without significant increase in productivity, reversal of international price increases and a decline in domestic demand growth?

The BB's assessment of global price outlook does not, and rightly so, suggest that international price increases will be reversed in FY23. Padma Bridge will boost productivity growth for sure, but certainly not dramatically so in the short-run.

The FY23 budget is expansionary. The only likely source of a slower demand growth is subsiding pent-up demand. It is hard to believe it will be enough to reverse the rise in inflation as projected when all other factors are working against such a reversal.

The policy stance for FY23 is described as "tight" and "cautious". 

The tightness can be found only in the increase in the policy (repo) rate by 50 basis points.  With the lending rate capped at 9 per cent, and the weighted average lending rate at 7.1 per cent in May, there isn't much wiggle room for transmission of the higher policy to the rest of the economy.

Moreover, with long-term treasury bonds priced between 7.8 and 8.4 per cent, who would want to lend to the private sector at 9 per cent when it is inherently risky and the regulator keeps extending forbearance on nonrepayment?

The supply of T-bills and bonds will have to dry out completely to make the lenders interested in other lending options. The BB has committed to remaining "watchful of this lending cap issue and taking policy actions if necessary."

The rest of the FY23 MPS is neither tight nor cautious. 

The broad money growth is projected to rise from 9.1 per cent in FY22 to 12.1 per cent, the public sector credit growth to rise from 27.9 per cent to 37.3 per cent and the private sector credit growth to rise from 13.1 per cent to 14.1 per cent. 

Some of the measures announced are in fact likely to be inflationary. Further increases in LC margins on non-essential imports will push up prices even if they are effective in reducing the demand for foreign exchange. The promised new refinance line for import substituting products and continued support to stimulus packages are expansionary measures. 

When import substitutes themselves depend on import of raw materials, intermediate inputs, and capital goods, even the intended reduction in demand for foreign exchanges is unlikely to result, at least in the short run. The BB has probably attained the unique status of a central bank that has coopted "import substitution" as part of its policy objective.

The MPS appears rather complacent on its stance on the exchange rate while recognising that the taka is currently overvalued based on the real effective exchange. Risking undervaluation, rather than overvaluation, is the most appropriate way for a central bank to provide protection to both imports substituting and export-oriented industries.

It is hard to fathom why the BB has chosen something pretty much outside the domain of monetary policy while maintaining a foggy stance on the exchange rate, something at the core of monetary management.