Curbing inflation is priority over high growth now

Recently, Bangladesh Bank announced a new monetary policy. This was the second monetary policy for the current fiscal year (2024-25) and the first one formulated under the present interim government. For quite some time, economists had been discussing the proposed monetary policy. Given the ongoing trend of high inflation in the country for nearly three years, there was significant interest in what kind of monetary policy would be adopted.

Following the COVID-19 pandemic, when the global economy was in a recovery phase, the Russia-Ukraine war erupted. As a result, inflation surged to unprecedented levels in many countries, even causing concerns in powerful economies like the United States. At one point, U.S. inflation reached 9.1%, the highest in 40 years. The Federal Reserve Bank of America (the Fed) managed to control this inflationary pressure by raising policy rates multiple times and implementing other measures. Following the Fed’s lead, at least 77 central banks worldwide increased their policy rates, including Bangladesh Bank. Bangladesh’s policy rate, which was once 5%, has now risen to 10%. However, despite this, there are no clear signs that high inflation is coming under control.

Many believe that although Bangladesh Bank repeatedly increased the policy rate, it had kept the maximum interest rate on bank loans fixed at 9% for a long time. As a result, efforts to control inflation through policy rate hikes were ineffective. Recently, Bangladesh Bank raised the policy rate to 10% and introduced market-based interest rates on bank loans. Consequently, borrowing from banks has become more expensive for entrepreneurs. Currently, private sector credit growth has declined to 7.28%, while bank loan interest rates have exceeded 15-16%. This has significantly reduced the tendency of entrepreneurs and general borrowers to take loans, raising concerns about stagnation in investment. Moreover, foreign direct investment (FDI) in the country has dropped abnormally.

In the first quarter (July-September) of the current fiscal year, Bangladesh attracted only $104 million in FDI, while $969 million was invested abroad, and $865 million was withdrawn by foreign investors. As a result, net investment stood at just $104 million. At the same time, capital machinery imports decreased by 26%, and imports of raw materials and intermediate goods also declined sharply. These statistics indicate that the country lacks a conducive investment environment. As of December, revenue collection fell short of the target of BDT 2,14,143 crore, with only BDT 1,56,419.49 crore collected. The tax-to-GDP ratio currently stands at 7.50%, the second-lowest in South Asia.

Given this economic reality, a contractionary monetary policy was expected. Bangladesh Bank has formulated its monetary policy with this reality in mind. Economists believe that controlling high inflation and bringing it to a tolerable level is more urgent than achieving high economic growth at this moment. I also agree with this perspective. However, I do not fully accept that inflation can be controlled solely by raising interest rates on bank loans. Higher interest rates will increase borrowing costs in the private sector, making loans more expensive and discouraging entrepreneurs from taking loans. This could lead to stagnation in investment. If private sector investment does not reach the desired level, production will decrease, limiting new employment opportunities and worsening unemployment. Ultimately, poverty alleviation efforts will be hindered.

Increasing loan interest rates may reduce demand for credit, but it will also negatively impact credit supply. In Bangladesh, most investors rely on bank financing due to the lack of alternative funding sources. The country’s stock market has not developed enough to serve as a major source of long-term investment funding. In contrast, in developed countries, long-term investments are financed primarily through the stock market. If long-term loans are taken from banks, repayment issues may arise. For example, if a project is expected to be completed in six months but takes a year or more, the burden of loan repayment begins even before production starts. However, if funding is raised through the stock market, such difficulties do not arise. Despite discussions about stock market development, it has not yet played a significant role in investment. Many large industrial enterprises remain outside the stock market because entrepreneurs fear losing family control over their businesses and facing regulatory obligations.

Industrial investors in Bangladesh have long demanded lower bank loan interest rates, arguing that high borrowing costs increase production expenses, making Bangladeshi products less competitive both locally and internationally. Rising costs of essential production inputs like electricity, gas, and fuel have prevented many industrial firms from operating at full capacity, leading to reports of factory closures. If the industrial sector and other production sectors cannot function normally, controlling inflation in the long run will be extremely difficult. Bangladesh Bank has stated that inflation will drop to 7-8% in the next two to three months. However, if production costs continue to rise, industrialists will be forced to increase product prices, disrupting the inflation control process. This could also harm export trade. International consumers prefer high-quality products at competitive prices. If the prices of Bangladeshi products rise, foreign buyers may shift to alternatives from other countries.

The United States' new administration has decided to impose higher tariffs on imports from China, Brazil, and Canada. If implemented, this could create greater opportunities for Bangladesh to export to the U.S. market. However, if we fail to ensure high product quality and competitive pricing, we may not fully capitalize on this opportunity. Moreover, the U.S. has suspended Bangladesh’s Generalized System of Preferences (GSP) benefits. Despite various efforts, the previous government was unable to restore this facility. Therefore, expecting a significant increase in exports to the U.S. solely due to tariff hikes on Chinese, Brazilian, and Canadian products may be unrealistic. If the prices of Bangladeshi export products rise, it could reduce American consumers’ purchasing power, leading to lower demand.

For the interim government, the biggest economic challenge is controlling high inflation and making life bearable for the general population. People are struggling significantly due to inflation. Although the current government inherited this crisis, it must take the initiative to resolve it. Inflation cannot be controlled by monetary policy alone—other effective and complementary measures must also be taken. In particular, strict action is needed to curb widespread extortion in the transport sector and to dismantle monopolistic business syndicates in the market. In the long term, efforts must be made to increase production across all sectors.

Dr. A.B. Mirza Azizul Islam: Economist and Former Advisor to the Caretaker Government
Transcribed by: M.A. Khalek