BB plans to cut policy rate, experts urge caution

Highlights:

• Bangladesh Bank may cut policy rate by 50 basis points
• New governor prioritises lowering lending rates, boosting growth
• Economists warn rate cuts could worsen inflation
• Tight policy reduced inflation, but above 8%
• Banks constrained by high defaults and weak capital
• Analysts favour maintaining tight stance for credibility

The Bangladesh Bank plans to cut policy rate – a major shift from tight monetary policy after the appointment of new governor – aiming to reduce lending rate demanded by the business community.

Governor Md Mostaqur Rahman, who vowed to lower lending rates on his first day at office last week, has called a Monetary Policy Committee meeting for Wednesday, according to central bank sources.

The committee may propose a 50-basis-point cut to the policy rate from the existing 10%, as the new governor signalled on his first day in office, a senior Bangladesh Bank executive said.

However, economists and bankers said reducing rates while inflation remains elevated could reverse recent gains. They believe any cut should be limited and cautious if inflation is to be brought down.

Meanwhile, interest rates in the call money market and on all treasury bills and bonds fell below the 10% policy rate on Sunday, giving the central bank room to reduce the rate.

According to the Bangladesh Bank, the cut-off yields on 91-day, 182-day and 364-day treasury bills were 9.89%, 9.97% and 9.93% respectively, while the call money rate stood at 9.89% on Sunday.

The prospective shift in monetary policy comes as global energy markets face one of their gravest shocks in decades, following joint US and Israeli strikes on Iran and Tehran's retaliatory missile attacks, which could worsen inflationary pressures.

The Bangladesh Bank maintained a tight monetary policy during the interim government's tenure, raising the policy rate from 8.5% to 10% to contain inflation.

The latest monetary policy, announced by former governor Ahsan H Mansur just ahead of the February national election, kept the rate unchanged at 10% due to persistent inflation.

Under the tight stance, the central bank brought inflation down from double digits to single digits over the past year, although it remains above the desired level. The previous target was to reduce inflation to below 7%, but it is still above 8%.

According to Bangladesh Bank data, average inflation stood at 8.66% at the end of January, while lending rates ranged between 11% and 12%.

However, soon after taking office, Mostaqur Rahman, who is also a businessman, said he would prioritise reducing lending rates and supporting growth.

Speaking to The Business Standard, a senior central bank executive said inflation had not fallen to the expected level despite the tight policy.

He said the Bangladesh Bank is now considering easing its stance to support the supply side by injecting liquidity, arguing that increased production and supply could help ease inflationary pressures.

'Infrastructure problems must be resolved first'

Mutual Trust Bank Managing Director Syed Mahbubur Rahman said bankers also want lending rates to fall, but prevailing market realities make that difficult.

"At present, the government is the largest borrower. When the government is borrowing at 10% or more through treasury bills and bonds, it is extremely difficult for banks to reduce lending rates," he said.

He further explained that some banks are now offering up to 11% interest to mobilise deposits. "How can loans be offered at lower rates after borrowing at such high costs?" 

He added, "Many say high lending rates are a major obstacle to investment. We also agree high rates are a barrier, but they are not the only or principal one."

He explained that when an investor decides to invest, the first considerations are gas, electricity and port facilities. "At present, shortages of gas, electricity and infrastructure are the main challenges for investment."

He suggested that to boost investment, infrastructure problems must be resolved first and the issue of lowering lending rates can then be addressed.

He hoped the new governor would continue the ongoing reform initiatives in the banking sector. If a firm message is not delivered at the outset, vested interests may try to return the sector to its previous state. 

'Rate reduction should be cautiously limited'

Fahmida Khatun, executive director at Centre for Policy Dialogue, told TBS that bringing down inflation while simultaneously lowering interest rates would be highly challenging.

She said that during the Awami League government's tenure, inflation kept rising as interest rates were not increased to a rational level, allowing price pressures to intensify.

"The interim government took policy measures and raised interest rates, which helped contain inflation to some extent. However, in my view, if we are to bring inflation down to 5-6%, this policy stance needs to continue," she said.

She noted that there is some justification in the argument that lower rates are needed to stimulate credit growth. "Even if the central bank decides to reduce the policy rate at this stage, it should be done in a very limited and cautious manner," she added.

'Surge in credit demand could prompt BB to inject liquidity'

Mohammad A (Rumee) Ali, former deputy governor of Bangladesh Bank, said lending rates remain high due to elevated inflation and mounting default loans in the banking sector. He said lending rate reduction will make money easy creating more demand.

However, he warned that if rates are lowered without first containing inflation and ensuring productive use of credit, it could further fuel price pressures.

"Banks are constrained in their lending capacity because of high non-performing loans. A surge in credit demand could prompt the central bank to inject liquidity, increasing the risk of further inflation," said.

'Maintaining existing tight monetary stance more credible route'

Zahid Hussain, former lead economist at the World Bank's Dhaka Office, said easier credit and lower interest rates tend to boost import demand, placing added pressure on the taka. 

Any depreciation of the currency then feeds directly, and often asymmetrically, into non-food inflation, he said.

Within this framework, he added, non-food inflation functions like core inflation. "It does not necessarily signal excess demand. Rather, it reflects how earlier food price shocks and exchange-rate pressures are transmitted across the economy."

Movements in the taka are quickly passed through to the prices of imported goods, energy, transport and other non-food items. Core-like indicators are therefore useful in tracking transmission effects, but they should not be read as evidence of overheating demand or expanded policy space.

He argued that maintaining the existing tight monetary stance, alongside exchange-rate stability and stronger competition in food markets, offers a more credible route to sustained disinflation than premature easing under the current inflation regime.

Business community gets priority to business oriented governor

Bangladesh Bank has appointed a new governor at a time when the banking sector faces a record 36% default loan ratio, sharply limiting lending capacity and disrupting normal operations.

Addressing the default crisis was not among the priorities he outlined on his first day in office. His appointment as a career businessman drew criticism within the industry over potential conflicts of interest. Of his 11 stated priorities, four focused on supporting the business community.

It is the first time a businessman with interests in garments and real estate has been made governor of Bangladesh Bank.

He himself had been a defaulter until two months ago, before obtaining loan rescheduling under a policy committee decision in December. He has also prioritised reopening closed industries to revive business activity.

With inflation still high, his focus on reopening factories has prompted speculation that loan rescheduling may be accelerated, as many closures stem from loan defaults.

A 10-year rescheduling package with a two-year grace period, introduced in September, faced strong resistance from banks, which questioned its effectiveness.

Of 1,500 applicants, only 300 received approval from the central bank's policy committee, and most of those cases remain unimplemented.

'Most banks unable to expand lending'

Speaking to TBS, a managing director of a private commercial bank, requesting anonymity, said the sector is in dire straits due to unusually high default loans. 

Of 61 banks, no more than 12 are able to extend fresh credit. He said five banks have merged, around 10 are critically exposed, and another 20 remain vulnerable though not publicly identified.

Referring to large banks whose boards were reconstituted after the regime change, he said deposit inflow appears strong as confidence returned. In reality, however, capital has been eroded by default loans, restricting lending capacity.

Although liquidity has increased as deposits returned, most banks cannot expand credit without first rebuilding capital through lower defaults. In this context, the sector lacks the capacity to meet large corporate credit demand.

He warned that loan rescheduling promoted by Bangladesh Bank may not be recognised by global rating agencies or multilateral lenders. 

The International Monetary Fund requires rescheduled loans to be classified as stressed assets alongside defaults, limiting any cosmetic improvement in ratios.

As a result, rescheduling alone may not lift the country's credit profile. He alleged that many firms seeking long-term rescheduling defaulted due to corruption and fund diversion.

Citing a major real estate group, he said inspections found fund diversion behind its default, despite a request for a 10-year rescheduling with a two-year grace period.

Many applicants, he added, have debt-to-equity ratios above 100% and would struggle without fresh equity. A grace period in such cases could strain banks' cash flows and deepen systemic weakness.

He also noted that the government faces a funding squeeze and is borrowing heavily from banks. Any policy rate cut to lower lending rates could spur credit demand, forcing the central bank to inject liquidity and heighten inflation risks.

Excess liquidity stood at Tk3.21 lakh crore at the end of last year, largely invested in treasury bills and bonds. Yet private sector credit growth remained at a historic low of 6%, reflecting weak expansion demand.