Addressing the key challenges of inflation, banking, external sector & capital market

Inflation currently poses a major challenge to Bangladesh's economy. In FY2025, inflation surged to 9.94 per cent, the highest in 12 years, exceeding the target of 7.5 per cent. Despite this, the interim government projected that inflation would fall to 6.5 per cent by 2026, which appears overly optimistic. According to predictions generated by the Multi-layer Perceptron forecast, inflation will unlikely decrease to 6.5 per cent by next year if current conditions persist.

It is important to underscore that supply-side and demand-side factors drive inflation in Bangladesh. Increasing costs of imports due to the depreciation of the Taka, rising global commodity prices, global supply chain disruptions, and the oligopolistic structure of local suppliers significantly contribute to supply constraints and, thereby, inflationary pressures, particularly in food inflation. Food inflation has been notably higher in urban areas than rural regions, while non-food inflation is comparatively greater in rural areas. This further necessitates region-wise targeted policy to address inflation challenges, especially for low-income households. Conversely, demand-side factors, such as an increase in the money supply, may also play an important role in rising inflationary pressures in Bangladesh.

In FY2023, Tk 700 billion was printed for quantitative easing during the tenure of the autocratic regime. An analysis using a Vector Autoregressive (VAR) model and Granger causality tests revealed that an expansion in the money supply is associated with rising inflationary pressures, albeit with a moderate statistical significance. This supports the quantity theory of money (QTM), where more money in circulation fuels inflation. To address inflation, suggested policies include boosting domestic supply to reduce import dependency, regulating oligopolies, and maintaining buffer stocks to cushion supply shocks. BANKING: Bangladesh's banking sector faces deep-seated challenges, including deteriorating capital adequacy, surging non-performing loans (NPLs), weak governance, and political interference.

Key indicators reveal severe vulnerabilities, particularly in State-Owned Commercial Banks (SCBs), where the Capital-to-Risk Weighted Assets (CRWA) ratio turned negative in 2024 and NPLs skyrocketed to BDT 3,457.65 billion by Q2 FY2025, exposing long-concealed weaknesses. Alarmingly, the volume of bad loans far exceeds annual allocations for education and health, highlighting a critical misallocation of resources.

Governance failures, such as politically appointed bank boards, lax internal controls, and weak regulatory oversight, have exacerbated systemic risks. The dual regulation by the Ministry of Finance and Bangladesh Bank undermines central bank independence, while legal inefficiencies delay loan recovery. Recent reforms, including stricter provisioning rules, adopting Expected Credit Loss (ECL) methodologies, and enhanced stress-testing frameworks, aim to improve transparency and risk management. Additionally, measures to professionalise bank management, restrict insider lending, and enforce dividend policies signal progress. However, sustained reform requires stronger political commitment to depoliticise banking operations, close legal loopholes, and hold wilful defaulters accountable. Immediate actions, such as freezing defaulters' assets and enforcing single borrower exposure limits, are crucial. Without systemic changes, the banking sector's instability will continue to hinder economic growth and financial stability.

The banking sector urgently needs bold, long-term reforms to restore confidence and integrity in Bangladesh's banking system.

EXTERNAL SECTOR: Amid the generally subdued macroeconomic performance during the ongoing FY2025, the external sector was a beacon of hope and resilience. The key external sector indicators evinced encouraging trends against robust remittance flows and impressive export performance. The deficit in the trade balance was contained, and the current account and overall balance of payment situation improved tangibly. The high B/B L/C payments for export-oriented intermediate goods also augur well for the performance of the export sector in the coming months. All these had positive implications for foreign exchange reserves- the decline was stalled, and an upturn is already visible. Since January 2025, the exchange rate has stabilised at around BDT 122-123 per USD, helping to ease the pressure of imported inflation.

However, not all trends are positive. Whilst imports did pick up somewhat, the growth has been slow. Growth of imports of capital machinery, as also L/C opening and L/C closing for these items, was negative, indicating that domestic investment remained timid. Exports remain volume driven, alluding to the urgent need for renewed efforts at productivity enhancement and an energetic move towards market and product diversification. The shift from a pegged currency system to a market-driven (managed float) exchange rate system will mean that exchange rate management must be carried out strategically.

The emerging and evolving global trading scenario is becoming increasingly challenging for Bangladesh's external sector performance. The uncertainties for Bangladesh originating from the Trump reciprocal tariffs must be addressed in a time-bound, evidence-based and informed manner. A Free Trade Agreement (FTA) with the USA may be put on the cards, but this will call for properly articulating Bangladesh's offensive and defensive interests. The non-tariff barriers India has put in place will be harmful to Bangladesh. These will need to be addressed in two ways- through proactive discussion and by putting in place measures to reduce dependence. As never before, Bangladesh's negotiating capacity will be tested in the coming days. Given this, Bangladesh should consider setting up a dedicated Negotiating Wing to undertake the anticipated bilateral and multilateral discussions. All these should be an integral part of Bangladesh's efforts towards smooth and sustainable LDC graduation.

CAPITAL MARKET: During the first nine months of the interim government, the capital market's performance fell short of expectations, which may be attributed to a combination of ongoing corrective sectoral measures and the lingering effects of past market irregularities. Already, nine months have passed since the new government took over, yet no new IPOs have entered the market; ongoing political uncertainty has narrowed the scope of new IPO enlistment to a further extent. During the last nine months, several strategic decisions have been taken to reform the capital market.

Yet, the implementation process appears to have slowed down due to the commission's bureaucratic procedures and administrative complexities. In this regard, the BSEC should accelerate its administrative decision-making process and ensure the timely submission and implementation of the task force's forthcoming recommendations. BSEC should also introduce an Investor Protection Fund to safeguard retail investors from losses due to fraud or manipulation.

CONCLUSION: The government has initiated several reform measures recently, including separating the National Board of Revenue into two departments - the Revenue Policy and Revenue Management - to improve revenue collection and efficiency, alongside measures aimed at enhancing stock market performance and attracting FDI. Additionally, steps have been taken to address the structural weaknesses in the banking sector, aiming to improve governance and resilience.

However, the success of these initiatives has been limited so far. For example, the NBR reform has faced resistance from within the tax administration, leading to temporary disruptions and necessitating further consultations to address concerns. Governance challenges and regulatory bottlenecks undermine investor confidence and impede economic potential. The government must move beyond piecemeal measures and commit to comprehensive reform. In the upcoming fiscal year, the focus should be on strengthening institutions, improving governance frameworks, and ensuring transparency and accountability in policy implementation. Only with visible and bold reforms can Bangladesh's economy build resilience, attract investment, and sustain inclusive growth in the years ahead.

Dr Fahmida Khatun, Executive Director, Centre for Policy Dialogue (CPD); Professor Mustafizur Rahman, Distinguished Fellow, CPD; Dr Khondaker Golam Moazzem, Research Director, CPD; Mr Muntaseer Kamal and Mr Syed Yusuf Saadat, Research Fellows, CPD. moazzem@cpd.org.bd; avra@cpd.org.bd

[Abu Saleh Md Shamim Alam Shibly and Tamim Ahmed, Senior Research Associates; Afrin Mahbub, Preetilata Khondaker Huq, Anindita Islam, Md Mehadi Hasan Shamim, Nuzaira Zareen, Ayesha Suhaima Rab, Safrina Kamal, Khaled Al Faruque, Md. Imran Nazir, and Tanbin Alam Chowdhury, Programme Associates; and Syeda Safia Zahid, Research Intern of CPD provide research assistance.]