Reining in inflation: Looking beyond policy tools

Experts' suggestion to reduce the inclusion of new development projects in the public sector to help combat inflation effectively needs to be taken seriously. The participating experts in a dialogue organised by the Business Initiative Leading Development (BUILD) in Dhaka early this week recommended a slowdown in development activities for now, as interest rate mechanism introduced lately might not be enough to contain the soaring inflation, The Bangladesh Bank (BB)'s new monetary policy statement (MPS) for the first half of the current fiscal year, FY (2023-24) has brought about a structural change in its monetary policy framework through raising policy rates and removal of the lending cap. It is expected to set a market-based reference rate for banks to fix lending rates. Therefore, the areas of change in the MPS include a policy interest rate corridor (IRC) and a reference interest rate for lending, the so-called SMART (six-month moving average rate of treasury bills). The reform also includes exchange rate unification and a revised method of calculating the gross international reserves. The change in approach regarding monetary tool based on interest rate is obviously a major shift from the earlier monetary-targeting framework to an interest-rate targeting one.

True, BB's previous rigid stance towards interest rate of not allowing it to be determined by the market did not actually bear fruit so far as its objective to maintain the private sector's competitiveness was concerned. Without addressing the structural bottlenecks and improving governance, a low interest rate is not of much use in maintaining competitiveness in economy. So, with the new framework targeting interest rate, the interbank call money rate will remain closely aligned with the policy rate so as to keep the interest regime predictable. The raised policy rate would make borrowing costlier thereby curbing inflation, it is hoped.  It is also expected to promote competitiveness within the banking sector and create a helpful lending climate for businesses and other entities. 

Now that a month has passed since the MPS has been put into effect by the central bank, the businesses and all others concerned would like to have a review of how far the new monetary policy could do justice to its stated objectives.  In a recent dialogue attended by business leaders, central bank executives, academicians and experts dwelt at length on the new policy measures of the BB and their impact on the economy. However, when there is an inherent dichotomy between fiscal and monetary policies, the objective of holding inflation in check at the targeted 6.0 per cent remains a big challenge. For inflation is linked to a host of factors of which the government's borrowing from the central bank and taking up new development projects are important contributing factors. Also, questions will remain as to how far the banks' current lending rates will be able to offset the high inflation rate, which rose to 9.94 per cent in May 2023. Compared to the inflation rate, the banks' interest rate till that time was in fact in the negative.

So, in the light of these considerations, some experts and business leaders were of the view that besides the two policy instruments to combat inflation and establish a market-oriented lending regime, though somewhat circumscribed by the interest rate corridor (IRC), some additional measures need to be taken. For instance, some screening of development projects could be done with a view to reducing fiscal deficit. Also, the monetary and fiscal policies should be in sync so that they are not at cross purposes. As expected, the central bank should be able to judiciously balance its fiscal and monetary tools to draw expected results from its stated monetary policy.