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FRIDAY, JUNE 20, 2025
What might be the short-term risk-free interest rate?

Thoughts

Mohammad Shahazadul Alam Khan
13 September, 2024, 09:50 pm
Last modified: 13 September, 2024, 09:52 pm

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What might be the short-term risk-free interest rate?

Bangladesh's economic landscape is evolving rapidly, and short-term interest rates are a critical component to consider throughout this transformation

Mohammad Shahazadul Alam Khan
13 September, 2024, 09:50 pm
Last modified: 13 September, 2024, 09:52 pm
Illustration: TBS
Illustration: TBS

Forecasting short-term interest rates involves predicting how a country's central bank might adjust its policy rate, which directly influences short-term interest rates. This process can be complex and typically requires analysing several factors, including macroeconomic factors, monetary policy stance, global economic environment, and last but not least, market expectations. 

If we analyse the status of those factors in Bangladesh, then we might have a view of the Bangladesh's economy's short-term interest rate.

Macroeconomic indicators are statistical measures that assess an economy's overall performance and expansion over a period. These indicators serve as valuable tools for policymakers, economists, investors, and traders to analyse trends, recognise potential challenges, and develop appropriate policies.

Inflation: Central banks often adjust interest rates to control inflation. Higher inflation may lead to higher interest rates. The trend of point-to-point inflation is upward.

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Most people believe that the published inflation is not accurate and actual inflation is higher than the published one at least. Due to basket selection and weight of commodities in the basket, intention understated the actual inflation.

 If we simply consider the daily necessary commodities such as rice, oil, eggs, and salt, then we see that prices almost exceed 26% to 110% of essential commodities in Dhaka only (not considering the averaging concept).

Here, a simple average of the above products is 51% (avoiding the weighted average to avoid bias and also needs higher statistical analysis). Then how can an economy avoid such a price hike? Market forces might create a strong wave to neutralise the force by spreading the impact to all other macroeconomic indicators. 

Foreign reserve and exchange: The country's foreign exchange reserves are showing a decreasing trend. Currently, the country has only 4.5 months of capacity for import payments. Also, the broad money supply should match with the FX reserve; other currencies may depreciate further. 

Recently, the central bank announced that they will not sell any dollar from the reserve to the interbank to settle import settlements. This might put a little pressure on the USD/BDT exchange rate. 

This is also prevalent in that domestic currency depreciates gradually, and there is also a change to further depreciate the USD/BDT.

Monetary policy stance: A monetary policy stance is the central bank's outlook, guidance, or standpoint on monetary policy. It's a way of measuring how a monetary policy contributes to economic development to achieve the central bank's goals.

Central bank communications: Statements and reports from the central bank provide insights into future interest rate decisions. The current statement of the governor is quite clear: the central bank will follow a tightening monetary policy.

Increase policy rate: Historical patterns of interest rate decisions and the current policy stance are crucial for forecasting. Recently, the central bank increased the policy rate several times and also committed to increasing the rate further to curve the inflation rate. The current repo rate/policy rate is 9%, which was 8.50%. 

Within a very short period, the policy rate increase shifts upward, interpreting a tightening monetary policy. Within December 2024, the policy rate might be 10% or exceed 10%.

The current political situation and natural calamities such as floods might push the crisis further. As per the Ministry of Food weekly report, as of 11 August 2024, the current rice inventory is 14.07 lac metric tons. If production hampers, then a food crisis may occur, which ultimately fuels inflation. Up to 18 January, during the current FY 2023-24, the government and the private sectors have not imported any rice.

Foreign debt is another challenge, and it signifies that in the coming days currency might deteriorate further if we cannot control the broad money supply and increase the inflow of foreign c

The county's total external (public and private sector) debt stood at $99.30 billion as of March – according to data from the Bangladesh Bank – where China alone provided 35%.

All the indicators say that interest rates may go up. To find out how that might work out, we don't need to go that far. Almost two years ago, the same situation occurred in Sri Lanka. After their government fell, the new governor took the market measures as per the book. Their inflation reached 73.70% on Sep 22, and the USD/LKR rate touched 363.3 on October 22, 91 days after the T-bill rate increased to 33.14%. 

It took almost eighteen months after the initiative was taken, and then gradually the invisible hand of the market equalised the turbulence, and as of July 24, the inflation in Sri Lanka is 2.50%, the USD/LKR rate is 299.98 on Aug 24, and the 91-day T bill rate is 9.41% as of Aug 24.

Hence there is a huge upside risk in terms of the yield curve. One major difference is Sri Lankan external debt was more than 75% of their GDP on December 22, but as of much later, external debt is 14.22% of total GDP. We might not face a Sri Lanka-like rate hike, but a hike is certain. Even if the short-term rate breaks the highest rate of the yield curve, then the short-term Treasury bill rate might cross 15%.


Mohammad Shahazadul Alam Khan. Sketch: TBS
Mohammad Shahazadul Alam Khan. Sketch: TBS

Mohammad Shahazadul Alam Khan is the head of Asset Liability Management at a reputed private commercial bank.


Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.

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