Time for a new central bank and monetary policy
The year 2022 has been the most critical for the Bangladesh Bank in almost 20 years. In 2003, the central bank incorporated massive reforms. And in 2023, we need to see a similar transition. It's time for a new monetary policy, since many rules have been updated to fend off the crises in the external sector. The taka's value plummeted sharply in the last five months and the foreign exchange reserves came under serious strain for the first time in 14 years. The new governor took office at this critical moment and ushered in several changes conforming to market demands. The new monetary policy will spell them out more methodologically to address the concerns of the stakeholders.
The International Monetary Fund (IMF) delegation that recently visited Bangladesh suggested that the central bank review its monetary policy at least twice a year. That used to be the case, until the former governor suddenly decided that it would be announced annually, without any logical reason. Usually, central banks scale up the frequency of policy announcements as time demands, but ours took a regressive move. India announces monetary policy at least six times a year. We should do so at least quarterly, given the increasing ebbs and flows of the financial industry and globalisation. Otherwise, it will be a document of delayed policy signals, which fails to achieve its goals in a timely fashion.
The new monetary policy should embody the changes that include: 1) removing the lending-rate cap; 2) re-adopting a market-based unified exchange rate – free of the 2.5 percent incentive; 3) bringing the sanchayapatra under the banking accounts and letting the government borrow directly from the banking sector; 4) adopting a rule for the spread (lending minus deposit rates) by making it four percent at maximum for all banks to discourage their profit bonanza; 5) inflation targeting at the rate of five percent or below; 6) premium deposit rates for the poor and vulnerable women; 6) tougher stance on habitual defaulters; 7) lower lending rates for agriculture and small enterprises; 8) encouraging working capital and phasing out the long-term loans for big businesses; 9) designing policies to ensure the fastest possible distribution of remittances; 10) encouraging banks to expand agent banking, particularly in rural and less-privileged areas; and 11) forging a strategic alliance with post offices to make the best use of their widespread network for financial operations and deposit mobilisation.
Since the middle of 2022, the policy changes at the central bank have been so enormous that they have already made the old monetary policy largely defunct, requiring a new policy framework as soon as possible. The policy changes, as outlined in the 11 points above, if adopted, will deliver not only a new monetary policy, but also a new central bank by knocking down a series of non-market rules – some of which were imposed on them by the finance ministry. Let the central bank give a signal to the market that it runs based on its own judgement and research. Let it signal that this institution will favour hardworking enterprises and punish delinquent borrowers without surrendering to pressure from tycoons or the finance ministry.
The central bank must be clear and definite in lifting the cap on the lending rate. Fixing a 12 percent lending rate instead of the nine percent one is another kind of cap, and not a market-based solution. Rather, the lending rate should anchor in either the call money rate or the inflation rate or both. For example, it can be equal to the call money rate plus some reasonable percentage points, because the call money rate is the reflection of the short-term liquidity rate in the interbank market.
The second option is using the Fisher Equation that makes the nominal interest rate equal to the summation of a reasonable real interest rate and the expected inflation rate. This type of framework is dynamic and resilient to any hiccups in the market. Bangladesh Bank's fixing of the lending rate at 12 percent may seem attractive to commercial banks for now, but the ever-changing situation may make it bitter quite soon. Critics or experts will then advocate changing the rate again, and the government, as usual, will take a long time to adapt its stance. The very bureaucratic and clerical nature of responding to expert opinions or making necessary changes by policymakers in Bangladesh always damages the economy.
The central bank has entered a weird regime of multifaceted exchange rates. There is one rate for exporters, one for importers, one for remittance makers, one for bankers to buy dollars from the central bank, and so on. The effective remittance rate by counting in the fiscal incentive is different. In addition, the street market rates and hundi rates also dominate the foreign currency transactions to a greater extent. The central bank must come out of this bizarre mushrooming of exchange rates and implement only one or two exchange rates – as unified as possible by addressing the demand-supply outcomes of the market. Otherwise, both money laundering and black market operations will turn cancerous, making the dollar crisis and reserve depletion even worse.
The new monetary policy must spell out the goals afresh: 1) maximise employment and economic growth; 2) maintain price stability, a moderate level of inflation, and a market-based exchange rate; and 3) ensure a stable long-term interest rate for the economy. The policy must require all banks to submit their statements of employment generation, not just their marvellous success in profit-hunting. This is the time for the Bangladesh Bank to emerge anew to implement new monetary policy, which is much needed to avert the crisis and set the banking sector on a sensible path of development.
Dr Birupaksha Paul is a professor of economics at the State University of New York at Cortland in the US, and former chief economist at Bangladesh Bank.