Dissecting Bangladesh’s Tight Monetary Policy

Bangladesh Bank’s continued tight monetary policy and rising policy rates aim to tackle persistent inflation, but at a cost—investment is suffering. This article explores the causes behind the central bank’s actions, the resulting impacts on the economy, and what further steps are needed to effectively curb inflation without stifling growth.

Bangladesh Bank (BB) has maintained a tight monetary policy, continuing to raise interest rates to control persistent in­ation. While this move aims to tackle in­ationary pressure, it has negative e‑ects on investment. Unfortunately, the central bank seems to have no choice but to keep its monetary policy tight to curb in­ation. Let’s explore why BB has no other option but to restrict the money supply, the impacts of this policy, and what additional measures are needed to e‑ectively reduce in­ation. e current situation feels like a “tit for tat.” Bangladesh Bank had previously forced the banking sector to maintain interest rates in single digits, despite market conditions not supporting this policy. While interest rates were rising globally, the central bank insisted on capping them, leading to a mismatch in the money supply and increasing pressure on the local currency, eventually resulting in devaluation. Simultaneously, the central bank printed more money while global prices were rising, contributing to in­ation in Bangladesh. Although in­ation has eased globally, it remains above 9% in Bangladesh due to mismanagement in the money market. Despite e‑orts to keep interest rates low, investment remains sluggish as the overall environment remains unfriendly to entrepreneurs. Now, with tight monetary policy in place, Bangladesh Bank must o‑set the consequences of earlier policies that ­ooded the market with money, even though it discourages investment. In January 2024, credit ­ow to private rms grew by only 7.15%, the lowest since 2015, indicating that entrepreneurs are hesitant to invest in a high-interest rate environment. Several other factors contribute to their reluctance, including a lack of condence in market conditions. Despite these challenges, the contractionary monetary policy is helping to reduce in­ationary pressure. If the government strengthens market mechanisms and addresses issues like extortion, in­ation could drop more rapidly.

Effectiveness of the Monetary Policy

Maintaining a tight monetary policy is justied, despite the business community’s preference for a more lenient approach. Bangladesh Bank cannot take risks with in­ation rates remaining unacceptably high. However, a policy rate of 10% for an extended period cannot be the sole strategy for managing in­ation. Coordinating monetary policy with scal policy and better market management is essential. e central bank has rightly pointed out that proactive measures, such as monitoring commodity stocks, importing goods before shortages occur, predicting supply-demand gaps, and rationalizing import duties, could stabilize prices of essential items like rice, wheat, edible oil, and onions. However, a high policy rate alone cannot contain in­ation. BB must also consider supply-side constraints, which contribute to in­ation, and foster competition through good governance and coordinated e‑orts. e Ministry of Home A‑airs and the Ministry of Commerce should support the policy by addressing supply-side issues. e dominance of extortionists and the concentration of control over imported consumer goods among just a few entities have created an oligopolistic market structure, driving up prices. Strengthening coordination between the National Board of Revenue (NBR), law enforcement agencies, and Bangladesh Bank is crucial. Additionally, the Bangladesh Competition Commission needs to take a more active role in addressing market anomalies. Exchange Rate Issues Another misstep by Bangladesh Bank was capping the exchange rate, which articially kept the local currency overvalued. As a result, when the central bank was forced to adjust for the foreign exchange mismatch, the local currency devalued signicantly—by over 40% against the US dollar in just two years. e currency devaluation had a signicant impact on the price level in the country, as the cost of raw materials surged in response. While the exchange rate has stabilized, non-transparent interference in market-clearing rates will not prevent in­ation from rising. Market participants who honestly report exchange rates may be forced to reduce transactions or avoid foreign currency deals altogether. Uninformed interference in discovering market-clearing rates can exacerbate excess demand, leading to unintended consequences, such as speculative attacks on the currency and distorted economic signals. Consistency and transparency in policies are crucial to avoid these issues. If market participants believe Bangladesh Bank will not stick to its stated policy, it may lead to speculative attacks, misaligned exchange rates, and distorted signals in the economy.