Contractionary monetary policy alone can’t solve inflation woes

The Bangladesh Bank announced the second monetary policy of the current fiscal year on February 10, 2025. This was the second monetary policy for the fiscal year 2024-25 and the first policy under the interim government. There was considerable anticipation regarding the announced policy, and many experts had expected it to be contractionary in nature. Indeed, the policy can be described as contractionary in terms of its characteristics, as it focuses more on controlling the existing high inflation rather than achieving high growth.

In January, the growth of bank loans to the private sector was 7.28 per cent, the lowest in the past 11 years. During the same period, imports of raw materials, capital machinery, and intermediate goods for industrial use sharply declined. This suggests that the growth of investment in the private sector has significantly slowed down. Additionally, foreign direct investment (FDI) inflows have also decreased in recent times. In the first quarter of the current fiscal year (July-September), FDI inflows fell by 71 per cent. During this period, the amount of FDI that came into the country was 10 crore 40 lakh USD, whereas it was 36 crore USD in the same quarter of the previous fiscal year.
The Bangladesh Bank has kept the policy rate unchanged at 10 per cent, which means that the interest rates on bank loans will not decrease in the near future. In this situation, investment in the private sector may decline. Economists and experts believe that controlling high inflation cannot be achieved through a contractionary monetary policy alone. Rather, this could reduce the dynamism of the economy, which would have an adverse impact on overall production activities. A decrease in production in the productive sectors will result in fewer employment opportunities, which will hinder poverty alleviation efforts. Alongside efforts to control high inflation, it is necessary to maintain the creation of new employment opportunities. If suitable employment opportunities are created, they can empower consumers to cope with the effects of high inflation. Therefore, any initiative that destroys employment opportunities should be avoided. Efforts must be made to control high inflation while ensuring that employment opportunities remain open.

The Bangladesh Bureau of Statistics has published the overall economic data for the 2023-2024 fiscal year. The report reveals that the country's economy faced various challenges during this period. Overall, the GDP growth rate was 5.22 per cent. The agriculture sector grew by 3.30 per cent, the industrial sector by 3.51 per cent, and the services sector by 5.09 per cent. Among these sectors, the services sector performed relatively well. During the same period, the size of the GDP reached 33 trillion 46 billion 17 crore Bangladeshi Taka. The GDP growth target for the current fiscal year has been set at 6.8 per cent. However, this target is unlikely to be achieved due to the ongoing economic challenges. In this context, there is a high risk of a significant reduction in GDP growth.

Development partner organizations such as the World Bank and the International Monetary Fund (IMF) suggest that Bangladesh's GDP growth rate for the current fiscal year could be slightly above 4 per cent. It is worth noting that under the previous government, positive economic indicators were often presented at inflated levels. For example, export earnings, foreign exchange reserves, and GDP growth rates were shown to be higher than they actually were, while figures like import costs and inflation were underreported.

One example of this was the presentation of foreign exchange reserves. The previous government frequently boasted about the country's foreign exchange reserves, claiming they had reached 48 billion USD at one point, and that Bangladesh had the second-highest reserves in the South Asian region, just behind India. However, they never disclosed the exact amount of India's reserves. The Bangladesh Bank included $7 billion transferred to the Export Development Fund in its foreign exchange reserve figures, which was misleading. This is considered a form of deception because funds that are not readily available for use and cannot be utilized on demand cannot be counted as reserves. When the IMF provided a loan of 470 crore USD to Bangladesh, they imposed a condition that Bangladesh must follow the correct method of calculating foreign exchange reserves, which led the Bangladesh Bank to now disclose net reserves.

In the monetary policy announcement, it was stated that inflation would decrease to 7-8 per cent within the next 3-4 months. However, how this target will be achieved remains unclear. Simply raising bank loan interest rates cannot be the solution to controlling high inflation. The current interim government is merely dealing with the consequences of the previous government’s flawed policies. After the war in Ukraine began, the United States experienced its highest inflation rate in 40 years, reaching 9.1 per cent. During this time, the Federal Reserve repeatedly raised the policy rate despite the risks of slowing private sector investment. As a result of the rate hikes, US commercial banks had to pay higher interest to borrow from the central bank, leading to reduced demand for loans and a decrease in the supply of money in the market. Over time, this helped bring down inflation in the US, which recently dropped to 3.2 per cent. Following the example of the Federal Reserve, central banks in 77 countries worldwide have raised their policy rates.

Bangladesh was among the 77 countries that raised their policy rates. However, despite the repeated increase in the policy rate by the Bangladesh Bank, the maximum interest rate on bank loans was kept at 9 per cent for a long time. As a result, loans from banks became relatively cheaper. In this situation, a powerful group in the country managed to withdraw large sums of money under the guise of loans. Bangladesh Bank Governor Dr. Ahsan H. Mansur named several influential industrial groups and mentioned that even they do not know how much money they had removed from banks in the form of loans. Due to this flawed policy by Bangladesh Bank, an opportunity arose for the rise in high inflationary trends.

The US Federal Reserve, the central bank of the United States, has now started efforts to reduce its policy rate. A great example of controlling high inflation can be drawn from the troubled country of Sri Lanka. The inflation rate there had reached as high as 77 per cent, but now it has dropped to minus 2 per cent. Both the central banks of India and Pakistan have also started reducing their policy rates. Recently, a significant number of products saw a hike in taxes. Energy prices play a crucial role in driving inflation, but the Bangladesh government is not giving this issue the attention it deserves. Citing the rise in global fuel prices, the government had increased fuel prices by 42 per cent recently. At that time, it was stated that if fuel prices in the international market fell, local prices would be adjusted accordingly. Currently, global fuel prices have returned close to pre-Ukraine war levels, but no efforts have been made to reduce the local fuel prices.

As already mentioned, there is stagnation in private sector investment. The national budget for the current fiscal year has set a target to increase the share of private sector investment to 27 per cent of GDP. However, achieving this target is highly unlikely. For nearly the last decade, private sector investment has fluctuated between 22-23 per cent of GDP. Therefore, expecting a 4-5 per cent increase in investment in just one year is unrealistic. Per capita income has decreased in the last fiscal year. In the fiscal year 2022-23, the per capita gross national income of the country was $2,749, but it dropped to $2,738 in the most recent fiscal year. There is skepticism about the accuracy of the reported per capita income. The previous government tended to inflate this figure in order to showcase economic achievements. In FY 2019-20, the per capita gross national income was $2,024, and just one year later, in FY 2020-21, it increased to $2,591. Is this credible?

During the previous government's tenure, the country's banking sector was severely damaged, particularly with efforts to conceal the extent of non-performing loans (NPLs). According to the latest statistics, the amount of NPLs in the banking sector is about 284,000 crore BDT. However, when adding write-off loans, restructured loans, and loans under legal dispute, many believe that the actual amount of NPLs could exceed 600,000 crore BDT.

Economists argue that the primary objective should be to control high inflation and provide relief to the public, as three years of high inflation have disrupted the lives of ordinary citizens. Immediate action must be taken to reduce inflation at all costs. However, it is clear that high inflation cannot be controlled solely through monetary policy. If inflation is not reduced, any success claimed by the government will ultimately lead to failure.

MA Khaleque: Retired banker and writer on economic affairs.