BB withdraws policy interest rate hike initiative

Although Bangladesh Bank previously indicated that the upward trend in the policy interest rate would continue, it has now reversed its decision within a short period. According to the central bank, the monetary policy is on the right track, and there are no plans to increase the policy interest rate in the near future. Notably, the policy interest rate refers to the rate at which scheduled banks borrow short-term liquidity from the central bank. An increase in the policy interest rate raises the funding cost for scheduled banks, compelling them to charge higher interest rates on loans to individuals and businesses. The movement of loan interest rates, whether upward or downward, depends significantly on changes in the policy interest rate. However, other factors, such as social, economic, and political dynamics, also influence loan interest rates.

When the central bank feels that reducing liquidity in the market is necessary, it raises the policy interest rate. Conversely, to increase market liquidity, the central bank takes the opposite approach. Decisions on increasing or decreasing money supply are outlined in the declared monetary policy, with policy interest rate adjustments being a simple method for this purpose.

In economics, raising the policy interest rate is a common approach to controlling inflation when it surpasses desirable levels. A higher rate reduces the ability and willingness of businesses and individuals to take loans, limiting their spending and thereby curbing inflation. While reducing money supply through a higher policy rate can control inflation, its adverse effects are often severe. When the policy interest rate rises, banking becomes costlier, discouraging private-sector entrepreneurs from borrowing heavily, which can negatively affect investment and production. As a result, central banks generally avoid raising the policy interest rate unless necessary.

A few years ago, Bangladesh Bank’s policy interest rate stood at 5%. Scheduled banks borrowed from the central bank at this rate. However, in the aftermath of the COVID-19 pandemic and the Russia-Ukraine war, global supply chains were disrupted, triggering inflationary pressures worldwide. Even in the United States, inflation reached a 40-year high of 9.1%. In response, the U.S. Federal Reserve repeatedly increased its policy rate. Following the U.S., Bangladesh and 77 other countries raised their policy interest rates. Currently, Bangladesh Bank’s policy rate stands at 10%, double the previous rate.

The increase in the policy rate forced scheduled banks to raise their lending rates. However, until recently, Bangladesh Bank capped the maximum loan interest rate at 9%, making borrowing relatively cheaper. This cap on loan rates, despite the rise in the policy interest rate, was a significant policy error by Bangladesh Bank. Critics argue that the 9% cap primarily benefited specific groups by granting them access to cheaper loans, warranting an investigation into the officials responsible for this decision. If incompetence played a role, those officials should face accountability, as such misguided policies are detrimental to a market-driven economy.

Fixing the maximum loan interest rate at 9% during a period of high inflation allowed inflationary pressures to escalate. Many borrowers misallocated loans, diverting them to non-productive sectors. During this time, Bangladesh Bank set a private-sector credit growth target of 14.1%, but actual growth reached 14.7%, exceeding the target. Simultaneously, imports of capital machinery and raw materials declined significantly, indicating reduced industrial investment. Allegations also emerged of funds being diverted abroad.

The primary purpose of raising the policy interest rate is to reduce money supply and control inflation. However, Bangladesh Bank initially took counterproductive measures. Later, when the loan interest rate cap was lifted, lending rates surged to 13-14%. If this trend continues, private-sector investment will likely decrease, hindering economic progress. Private-sector investment is vital for achieving the robust growth required for Bangladesh's transition to a developing country by 2026.

The European Union has stated that Bangladesh will receive GSP (Generalized System of Preferences) benefits for three additional years after its graduation to a developing country. However, qualifying for GSP+ benefits requires meeting stringent conditions, which may be challenging for Bangladesh. Losing such trade privileges could reduce export earnings from the EU by 21%. Currently, nearly 48% of Bangladesh’s exports are directed to the EU.

Local investment is crucial for sustainable economic growth. To remain competitive, Bangladeshi products must be high-quality, durable, and cost-effective. The domestic market of 170 million people offers significant potential. With rising purchasing power, consumers demand better products, making competitive pricing and quality essential to retaining market share.

Entrepreneurs in Bangladesh often face capital shortages, making easy access to bank loans essential. Long-term investment should also shift from bank dependency to stock market financing. Ideally, 30-35% of GDP should come from private-sector investment, primarily in productive sectors. An economy like Bangladesh requires 4-5% investment growth for each 1% GDP growth. However, for the past 15-16 years, private-sector investment has stagnated at 22-23% of GDP.

Increasing lending rates to control inflation will impede private-sector investment. Bangladesh’s economy, reliant on 25% imports and 75% domestic production, raises questions about the persistent price increases for locally produced goods.

Inefficiencies in the marketing system, including excessive toll collection, hoarding, and exploitation, inflate prices. Farmers, despite rising production costs, struggle to receive fair prices for their produce. The declining profitability discourages agricultural production, threatening food security.

Research shows that soil fertility in Bangladesh has been declining. From 2011 to 2020, fertility dropped to a negative 0.44%, down from 3.3% in the previous decade. Addressing soil fertility and ensuring farmers receive fair prices is vital to prevent further deterioration in the agricultural sector.

M A Khalek is a retired banker and an economic analyst.