Prudent policy support is needed to implement expansionary monetary policy stance

Bangladesh Bank has declared its monetary policy stance for the fiscal year 2020-21 with an ultra-easing stance, keeping COVID-19 pandemic in consideration. The indicative policy instruments, such as bank rate, repo and reverse repo rates are brought down to reduce cost of fund, increase liquidity in the financial sector and support the economy. In that sense, earlier reduction of CRR (cash reserve ratio) and adjustments in ADR (advance deposit ratio) are consistent with current reduction in bank rate as well as Repo and Reverse repo rate, though the extent of easing seems to me somewhat overemphasized.

In my view, the success of the current monetary policy stance depends on three factors:  (i) Fiscal policy stance; (ii) Financial sector's response and (iii) Recovery of the economy. Let us discuss the monetary policy stance under these three aspects.

First, monetary policy is always complementary to the fiscal policy stance though the fiscal policy for the year in review was not that much expansionary, considering the widespread need to support a large section of the new and old poor as well as lack of a plan to revamp the public health sector. So, there remains a mismatch.

Moreover, since banks are involved in implementing government's stimulus packages, they need extra liquidity and respite in cost of fund in line with low-level interest rate structure. But, currently the banking sector is overwhelmed with liquidity due to staggered demand for loan as well as their struggle for implementing stimulus packages particularly for CMSME sector and agriculture sector due to policy constraint. Therefore, it is not the money, but policy guidance which is more important for supporting current fiscal stance and manage the covid-19 crisis.

Second, given the monetary easing, private sector credit growth should be under scanner. Easy money might flow to willful defaulters in the context of weak corporate governance in the banking sector. Since interest rate structure is fixed now, the monetary easing will only give the benefits to the banks by lowering its cost of fund. It might also create unhealthy competition among banks for deposit mobilization and lending. Therefore, banks' behavior would be important in taking advantage of this monetary policy stance. If Bangladesh Bank's prudent financial sector surveillance fails to check default rate and other anomalies in the banking sector, this monetary easing might result adverse consequences on the economy.

Third, the success of current monetary easing depends on the pace of economic recovery from the covid-19 pandemic. If investment environment does not bounce back, employment does not gear up, stimulus packages are not being implemented properly, there is high likelihood that the easy monetary policy might create inflationary pressure on the economy.

Therefore, there are some challenges in the implementation of the current monetary policy. It would have been better if Bangladesh Bank would declare monetary policy for the first half of the year (up to December 2020) as before. Definitely the response of the economy for the first half of this fiscal year would be quite different from the latter half of the year considering the covid-19 situation. While there is no such indication of containment of Covid infection in Bangladesh, and there are evidences of onset of second waves in many countries worldwide, a similar monetary policy response throughout the year is not a prudent policy stance.  The eased policy rates will give banks a respite, but the positive benefits of monetary policy will largely depend on the recovery phase of the economy as well as good governance in the banking sector.

I see that exchange rate management issue got less attention in the monetary policy stance. It has just mentioned that the trade-weighted NEER (Nominal Effective Exchange Rate) is slightly undervalued and both inflation and trade-weighted REER (Real Effective Exchange Rate) index is largely overvalued. In the recovery phase, as I mentioned in an article in this paper a few weeks earlier, exchange rate management would be a critical policy issue. Since the influx of foreign remittance with low growth of imports does not call for a depreciation at this moment, it is important to take corrective measures against REER slowly with a balance of the NEER to avoid any future crisis as well as to provide stimulating support to the export and remittance sector. I would say that NEER should be the main indicator to look for in this crisis situation because inflationary situation in our trading partner countries would be more volatile in the recovery phases. The policy of drastic stabilization of the REER might create volatility in our exchange rates and therefore is not recommended.

Bangladesh Bank has taken various proactive measures to implement stimulus packages and support the government's stances to manage Covid-19 crisis with its limited scopes. Though the expansionary policy stance is a welcome move, the central bank needs to be vigilant on the reactions of the various economic indicators in response to monetary easing, and they might be ready to make any required changes in its monetary stance at any time during the year. Prudent policy support is needed to make the monetary policy a success, though everything is not in the hands of Bangladesh Bank.

The author is a Senior Research Fellow at Bangladesh Institute of Development Studies (BIDS). He can be reached at monzur@bids.org.bd