Monetary policy pragmatic: economists

Economists lauded the central bank for its decision to keep the monetary policy unchanged for the second half of the fiscal year, saying it was the need of the hour.

The cautiously restrained monetary policy stance of the first half will be continued in the second half, without any new loosening or tightening, BB Governor Atiur Rahman said while announcing the monetary policy statement (MPS) last week.

The reasons cited then were: the annual average CPI inflation is still above the targeted ceiling, core inflation continues to be trending upwards and the political unrest was not subsiding even after 25 days.

“In the present context, the monetary policy has become irrelevant. Nothing has been functioning normally in these times of political upheaval,” said AB Mirza Azizul Islam, former adviser to a caretaker government, adding that the monetary policy was kept unchanged for the sake of continuity.

BB expects economic growth in fiscal 2014-15 to be a “respectable” 6.5-6.8 percent, which is below the government’s target of 7.3 percent but in line with the development partners’ forecasts. Accordingly, the ceiling for private sector credit growth has been kept at 15.5 percent, which is sufficient to accommodate any substantial rise in investment and trade finance over the next six months, the MPS said.

But Islam said the possibility of reaching the targets set in the monetary policy statement is very thin.

The extended political turmoil, the longest since 1996, has completely doused the investment demand. “And if there is no investment, there is no growth. The target cannot be reached,” the former caretaker government adviser said.

Meanwhile, Zahid Hussain, lead economist of the World Bank’s Dhaka office, said by keeping the policy rates unchanged and monetary growth in line with growth in nominal GDP, BB is signalling to the public that it is determined to keep inflation contained in order to generate sustainable growth.

The policy rate is the rate at which banks borrow from the central bank.

Despite expectations of a policy rate cut following the lead of several countries to boost investment, BB left the repurchase rate unchanged at 7.25 percent and the reverse repo rate at 5.25 percent.

The Reserve Bank of India cut the key lending rates — repo by 0.25 percentage points to 7.75 percent — in an effort to boost growth in Asia’s third-largest economy.

Canada, India, Singapore, Turkey and the European Central Bank have also cut their policy rates in recent times.

Since last June, inflation in Bangladesh has been decreasing and banks too have mounting excess liquidity, both of which raised hopes of a rate cut among experts.

In the first half of the current fiscal year, when things were calm on the political front, the private sector credit growth target of 14 percent was not met, which indicates low investment demand, Islam said.

Furthermore, since banks have huge excess liquidity a policy rate change would not have any effect on investment.

The primary factor holding back investment in Bangladesh today is not high interest rates — it is political instability and structural factors, Hussain said.

Even if BB cuts rates, banks, which are paying higher deposit rates, are unlikely to cut their lending rates to single digits, as the banks are facing high loan default rates, inflation and uncertainty.

Depositors, given their high interest rate expectations fuelled by downwardly rigid rates on the national savings instruments, will not settle for less than the rates the National Savings Directorate is paying them.

“This has placed a floor on deposit rates and thus on lending rates,” Hussain said, adding that the policy rate is missing the transmission mechanism through which it can affect investment or consumption demand, one way or the other.

A more important source of BB’s influence today is expectations. If people believe BB is serious about inflation, and their expectations of inflation start declining, inflation will also decline, the WB economist said.

So BB needs to take advantage of the current episode of food price disinflation to bring down expectations, which is yet another reason for not lowering policy rates now, according to Hussain.

Plus, BB’s 7.25 percent repo rate is already lower than India’s 7.75 percent and Sri Lanka’s 8 percent, he added.

Hussain said the economy is currently passing through an adverse supply shock due to disruption in the transportation system caused by the ongoing political unrest.  This has resulted in stagflation of an unusual kind.

“What we have is a fragmented economy in which some parts are caught in a “stag” (falling income and employment) mode and some in “flation” (rising prices) mode.  This has made the use of standard macro-economic demand management for controlling inflation and supporting growth especially challenging.”

The parts in “stag” mode can get out of it only when the supply chain disruptions end, he said, adding that the monetary policy stance is irrelevant to them.

The parts that are in “flation” mode risk fuelling it even more if monetary policy is expansionary.

So by keeping the policy rates unchanged and monetary growth in line with growth in nominal GDP, BB is signalling to the public that it is determined to keep inflation contained in order to generate sustainable growth, the WB economist said.

“Indeed the reason many central banks in the world today can keep policy rates low to foster growth is because they have fought the battle against inflation and convinced their citizens that, if need be, they will smite the inflationary beast again if it rears its ugly head.”

Hussain said Bangladesh is still not quite there, with the supply shock increasing the risk of resurging inflation and non-food inflation on the rise in November and December.