Nominal policy rate hike will have marginal market impact

The new monetary policy lacks real reform and does not appear to have any tangible impact on the economy. Instead, it essentially reiterates traditional policies.

The significant challenge in the economy lies in controlling inflation and implementing measures to boost foreign exchange inflow. While a contractionary policy was deemed necessary to control inflation, no concrete actions have been taken in the new policy.

Notably, the monetary policy has witnessed a 25-basis point increase in the key policy (repo) rate, aimed at increasing credit costs at the consumer level. However, the effects of this policy rate hike are expected to take a few months to manifest in the market.

The Bangladesh Bank has moved from monetary targeting to interest rate targeting since last July.

The policy rate along with the Interest Rate Corridor (IRC) for the money market rates supported by the Standing Lending Facility (SLF) and the Standing Deposit Facility (SDF) constitute the operating framework for interest rate targeting.

The central bank has given mixed messages by adjusting the policy rate and the rate corridor. They have increased the policy rate from 7.75% to 8%. This is the reason it has described the monetary policy as contractionary.

However, the contractionary stance is diluted by decreasing the SLF rate from 9.75% to 9.5%, thus making it cheaper for banks to borrow from the central bank through SLF. This injects a bit of an expansionary element into the policy stance.

The increase in the SDF rate from 5.75% to 6.5% is academic at a time when there is a liquidity crunch in the banking system.

Very few banks, if any, have excess liquidity. Why would the few, who may have such liquidity, put it into the SDF when the interbank money markets and short-term government securities are paying much higher rates?

It is not clear what the central bank is trying to achieve by reducing the width of the IRC.

To increase the interest rates on customer-level loans, increasing the corridor of the Six-month Moving Average Rate of Treasury bill (SMART) was deemed essential, as it would have an immediate impact on the market. However, the SMART corridor was expanded following the last monetary policy announcement, a move that the central bank is also capable of executing.

Our current foreign exchange rate is not in sync with the market. While announcing the last monetary policy, the governor said a market-driven exchange rate would be introduced by September 2023. But it did not happen. Now the central bank is planning to introduce a mechanism called the "crawling peg" for the exchange rate, but it's not clear how the mechanism would work.

The new policy provides no answer to solving our dollar crisis and our industries are suffering due to the dollar crunch.

The central bank consulted economists before announcing the monetary policy. The economists suggested some immediate steps – aggressive interest rate hikes and a market-driven exchange rate – in light of the current situation. But the central bank is saying they are not able to execute them at the moment.

The author is a former lead economist of World Bank's Dhaka office