BB signals further monetary tightening as inflation rages

The central bank has signalled that it would go for more tightening of the monetary policy since inflationary pressure shows no signs of cooling.

The Bangladesh Bank gave the hints about its upcoming measures in its monetary policy review for the just-concluded fiscal year. The report was released yesterday.

"Monetary policy would need to be restrictive for sufficiently long to return inflation to around the 7.5 percent target sustainably in the medium term, and further tightening would be required if there were evidence of more persistent inflationary pressures," it said.

Annual inflation rose to 9.73 percent in 2023-24, the highest since 2011-12 when it was 10.62 percent, overshooting the government's target of containing it to 7.5 percent, according to the Bangladesh Bureau of Statistics (BBS).

This is the second year in a row that the Consumer Price Index (CPI), a measure of the increase in the prices of a basket of products and services, crossed 9 percent. This means the monetary policy of the central bank could do little to bring it down although it initiated several measures, albeit belatedly.

With global components of inflation turning down, most countries have experienced a significant fall in inflation relative to its peak, said Lisa DeNell Cook, a member of the Federal Reserve Board of Governors of the US, at the Australian Conference of Economists in Adelaide of Australia, on Wednesday. 

Even cash-strapped Sri Lanka succeeded in controlling inflation. On the other hand, consumer prices have kept rising in Bangladesh. The government aims to contain it to 6.5 percent in the fiscal year of 2024-25, which begins on July 1.

In the review, the central bank said the lag effect of marked global commodity price hikes, partly exacerbated by the weaker exchange rate of the taka against US dollars, has prolonged the persistently high inflation.

"Inflationary pressures have also broadened within the core basket, reflecting spillover and second-round effects as well as the pass-through of costs associated with electricity generation."

It said despite decreasing trend of global commodity prices, Bangladesh's economy could not benefit due to the significant domestic currency depreciation, which subsequently raised import prices, thereby contributing to inflationary pressures.

The taka has lost its value by about 35 percent against the US dollar in the past two years. 

In FY24, the central bank adopted a tight monetary policy stance and raised the policy rate -- at which it lends to commercial banks -- on several occasions to lift it to 8.5 percent. The rate was hiked by 400 basis points since the middle of 2022.

The International Monetary Fund (IMF) has suggested the central bank raise the policy rate by 50 basis points by December this year since its monetary tightening is yet to rein in inflation.

However, most central banks stopped raising their policy rates over the past year. Some are considering how long to keep rates at restrictive levels or, if inflation picks up again, whether to raise rates further, according to Lisa DeNell Cook.

The BB said over the past year, fluctuations in fuel, food, and energy prices have been the predominant drivers of headline inflation, with food and fuel costs largely mirroring global commodity price trends.

It blamed higher food prices for the spike in demand ahead of Ramadan and Eid-ul-Fitr celebrations.

Among the components of non-food inflation, the highest rate was recorded in the health sector at 13.69 percent. followed by 11.34 percent in furnishings, household equipment, and routine maintenance of the house, according to the report.

In the review, BB Governor Abdur Rouf Talukder said Bangladesh economy was not immune to the impact of global issues, though it performed fairly well a couple of years after the Covid-19 recovery.

However, since 2023, the economy began feeling the pressures of persistently high inflation and the exchange rate depreciation, particularly through geopolitical tension and trade uncertainties, he added.

Despite the challenges, provisional estimates from the BBS indicate that gross domestic product (GDP) grew 5.82 percent in FY24, up from 5.78 percent in FY23, reflecting a modest improvement in the country's economic performance.

"To mitigate inflationary pressure and restore the stability of the exchange rate, BB upheld a hawkish approach to monetary policy throughout last year and continued the contractionary stance for the second half of the last fiscal year," he said.

The BB has not gained much success in curbing higher inflation because of the lack of a market-based interest rate system. In April 2020, the BB first introduced a 9 percent interest rate ceiling.

Although it was withdrawn in the first month of the last fiscal year, the banking regulator introduced a new interest rate system based on the six-month moving average rate of treasury bills known as SMART, which was still considered as another cap.

Finally, in May this year, the BB allowed banks to determine a market-driven interest rate in line with the IMF's prescription.

At a webinar recently, Birupaksha Paul, a professor of economics at the State University of New York, said the interest rate cap was largely responsible for the current inflationary pressure.

He explained when interest rates were increased all over the world to tackle inflation, the central bank walked in the opposite direction. The lending cap was withdrawn following the advice of the IMF.

In May, the BB also rolled out a more flexible exchange rate policy, moving away from its practices where banks would determine the price of the dollar in line with the verbal instructions of the central bank. 

The governor hoped that the crawling peg will help to tackle the present challenges.

Amid the persisting macroeconomic challenge, the BB is going to announce the monetary policy for the first half of FY25 in the third week of July. The main objective will be to control inflation and achieve the GDP growth target set by the government.

Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, recently said the policy rate would have to be hiked to control inflation.

"If the central bank and the government maintain strict policy measures, it will help reduce inflation."

The government has also set high bank borrowing targets for FY25, but banks are facing liquidity shortages. This prompts the economist to suggest the central bank be strict about refraining from granting loans to the government.