Cenbank plans policy rate hike in new monetary policy to tame inflation

The Bangladesh Bank is planning to raise policy rates in the upcoming monetary policy for the next fiscal year with the aim of taming inflation by making money costlier.

The hike in the key interest rates, also known as the repurchase agreement (repo) and reverse repo rates, will make money costlier, thereby discouraging banks from lending.

The repo rate is the rate at which banks borrow funds from the Bangladesh Bank, while the reverse repo rate is the rate at which banks deposit their excess funds with the central bank.

Also, the reverse repo rate will be renamed the Spending Deposit Facility Rate (SDFR) in the new monetary policy.

The policy rate is a monetary tool used to dampen credit demand, but despite rate hikes on a couple of occasions, credit growth remained upward owing to the lending rate cap.

However, in the new monetary policy, the central bank plans to move away from the lending rate cap regime and introduce an interest rate-based monetary policy, following the suggestion of the International Monetary Fund (IMF).

In the new monetary policy framework, the lending rate cap will be lifted, and a new lending rate formula will be introduced for commercial banks.

The new lending rate system is referred to as "SMART" – Short-Term Moving Average Rate. The six-month average interest rate on 182-day Treasury bills will be treated as the base rate. There will be a corridor rate along with it. This corridor may be around 3%. Banks can determine the lending rate by adding or subtracting the corridor rate from the Treasury bill rate.

Currently, the interest rate on 182-day Treasury bills is a little over 7%. This means the interest rate on consumer loans will be as high as 10%. Loans that are currently carrying 9% interest will also bear interest as per the new rate.

A central bank official said the corridor could be slightly lower than 3%. In that case, it will be possible to keep the lending rate in single digits.

According to industry insiders, if the lending rate cap is lifted, a policy rate hike will be effective this time. This is because it will make borrowing more expensive for banks, which in turn will push up lending rates, discouraging borrowers from taking loans at higher costs.

In today's board meeting, the central bank will approve the amount of the increase in the policy rate and changes in monetary policy. Subsequently, on 18 June, it will be published for all.

According to data from the central bank, the repo rate was raised by 25 basis points to 6% in the last monetary policy for the second half of FY23.

For the last time, on 11 June, seven banks and one financial institution borrowed Tk1,276 crore through a one- to seven-day repo.

A senior official at the central bank said that, despite various obligations, the Bangladesh Bank will prioritise reining in inflation as one of its major tasks in the new monetary policy. As part of this effort, it has been decided to increase the policy rate.

He also said the central bank used to formulate money supply-based monetary policy, but in the next fiscal year, it will shift towards an interest rate-based approach.

Interest rate-based monetary policy is a type of macroeconomic policy that is used by central banks to control the level of inflation and economic growth by influencing the interest rates in the economy.

The official said the central bank plans to slow down the growth of money supply in the market while also taking into consideration the need to achieve the desired GDP growth.

He said the decision on the increase in the money supply is made based on the inflation and GDP growth targets. Despite inflation currently exceeding 9%, the proposed budget aims to bring it down to 6% and sets the GDP growth target at 7.5%.

Md Habibur Rahman, chief economist at the central bank, told The Business Standard that a uniform exchange rate will be announced in the new monetary policy and then the central bank will no longer have a dollar selling rate. 

"The central bank will sell dollars from its reserves at a uniform rate determined by the market. In that case, the interbank exchange rate may be considered the base rate. However, no decision has been finalised in this regard yet," he added. 

According to data from the central bank, the last interbank dollar price was Tk108.50 on 12 June. Currently, there are at least five rates of the dollar in force in the market. These are the interbank rate, export proceeds, remittances, central bank dollar selling rate, and cash dollar rate.

The IMF made the single exchange rate conditional on approving the $4.7 billion loan to Bangladesh.