Success of controlled free market economy impossible

In the same way that one cannot win a footrace with a rope tethered to their feet, a free market economy cannot thrive under restrictive conditions. A free market economy isn't synonymous with a laissez-faire approach; rather, it requires certain conditions to function optimally. Regulatory oversight is essential to ensure that the natural flow of the market isn't obstructed. Intervention should only occur in cases of abnormal circumstances.

In the context of a free market economy, the market is considered the supreme authority. The price of a product or service will be determined based on market demand. No entity in the market will dictate the price or supply of a commodity. Product prices will be determined based on product availability and consumer demand. This is the fundamental principle of a free market economy.Therefore, it's imperative to recognize and preserve the fundamental principles that underpin a free market economy, allowing it to flourish and benefit society as a whole.

Bangladesh has ostensibly adopted a free market economy since the 1990s, yet it hasn't fully materialised as intended. Instead, we find ourselves grappling with a system that isn't delivering the anticipated benefits. In certain instances, the purported free market economy has even become a liability, with a notable absence of visionary leadership to address the issue. What's unfolding under the guise of a free market economy in Bangladesh can best be described as a controlled variant. Here, I aim to elucidate how a regulated market economy can pose significant risks to a nation's economic well-being.

The pivotal role of central banks and regulatory bodies in a free market economy cannot be overstated. While the governor of the central bank is typically appointed by the government's top tiers, it's crucial to afford them the environment and autonomy to operate independently. However, Bangladesh Bank, unfortunately, does not enjoy such autonomy. It faces constraints in making decisions autonomously, thereby undermining its effectiveness.

The banking system in Bangladesh operates under a dual governance structure, where Bangladesh Bank's control over privately owned banks is not as extensive as it is over state-owned banks. This imbalance often leads to instances where decisions made by Bangladesh Bank can be overruled by the Bank and Financial Institutions Department of the Ministry of Finance. Similarly, even if Bangladesh Bank opposes a decision, the Ministry of Finance's department can still implement it, as was purportedly the case with the approval of the last nine privately owned banks.

In one such instance, despite Bangladesh Bank's objections, the Ministry of Finance approved the establishment of new banks, allegedly driven by political considerations rather than economic necessity. This scenario underscores the dangers of allowing political motivations to influence the establishment of banks and financial institutions, as evidenced by past experiences.

It appears that Bangladesh Bank, at times, makes decisions detrimental to the country's banking sector and overall economy, potentially under external pressure from influential quarters. An example of this is when the then Governor of Bangladesh Bank made a public commitment to reduce interest rates on bank loans during a gathering of business leaders. Subsequently, the controversial 9-6 interest rate policy was implemented, wherein the maximum interest rate on bank loans was capped at 9 percent, and the interest rates payable on deposits were fixed at 5.5 percent for state-owned banks and 6 percent for privately owned banks.

This decision, taken in 2022, came at a time when interest rates on bank loans were elevated in many countries worldwide, and there was considerable demand for loans in Bangladesh. However, Bangladesh Bank's imposition of a maximum 9 percent interest rate on loans contradicted the principles of a free market economy. Moreover, by setting the interest rate on deposits higher than .5 percent for privately owned banks, there seemed to be an intent to incentivize depositors to favor these banks over state-owned ones. Consequently, the reduced limit for saving deposits in state-owned banks led state institutions to deposit funds in privately owned banks, jeopardising the financial stability of some state-owned enterprises.

When Bangladesh Bank established the maximum interest rate for bank loans at 9 percent, I discovered from a state-owned bank that their 'cost of funds' was 8 percent. If a bank expends 8.25 taka to generate an investable fund of 100 taka, the question arises whether the bank can indeed make a loan while profiting by only 75 paise. At that juncture, banks resorted to implementing various charges on loans as a means to navigate their operations.

Setting a maximum interest rate on bank loans inadvertently exacerbated the already high inflation rates. This decision seemed to favor a specific group of business entrepreneurs while simultaneously diminishing banks' profitability. Notably, among the influential entrepreneurs, loans were granted through various means, possibly circumventing standard procedures.

During this period, monetary policy aimed to limit the growth of bank credit to the private sector to 14.1 percent. However, in reality, the growth of bank loans to the private sector surpassed this target, reaching 14.7 percent. Concurrently, there was a noticeable decline in imports of industrial raw materials, capital machinery, and intermediate goods. This suggests that the bank loans received were diverted to other sectors instead of being utilised as intended.

The influx of loan money into the market without proper allocation and utilisation in the intended sectors led to an increase in inflation. This diversion of funds away from productive sectors potentially exacerbated inflationary pressures, highlighting the unintended consequences of monetary policy decisions.

Following the onset of the Ukraine war, a global trend of hyperinflation emerged, with the US economy experiencing a notable rise in inflation to 9.1 percent. In response, the US Federal Reserve Bank (Fed) raised its policy rate, prompting central banks in at least 77 countries worldwide to follow suit. When a central bank increases its policy rate, scheduled banks are required to pay higher interest rates when borrowing from the central bank. This results in increased borrowing costs for entrepreneurs, dampening their inclination to borrow at higher rates. Consequently, the circulation of money in the market decreases, thereby aiding in the control of high inflation. Many countries have successfully reduced their high inflation rates by implementing such measures, with economically distressed nations like Sri Lanka managing to bring inflation down from 35 percent to below 3 percent.

In Bangladesh, Bangladesh Bank has raised its policy rate multiple times in recent years, with the rate increasing from 5 percent to 8.5 percent. However, despite these efforts, the imposition of a maximum interest rate for bank loans at 9 percent has limited the effectiveness of Bangladesh Bank's policy rate increases in controlling inflation. Additionally, if the interest rate on bank loans were allowed to be market-based rather than regulated, it could have a more significant impact on inflation. The rationale behind Bangladesh Bank's continued regulation of bank loan interest rates, despite the potential benefits of a market-based approach, remains unclear.

A prime example of the consequences of regulating or chaining a free market economy is the control of exchange rates for foreign currencies, particularly the US dollar. Many economists think that the exchange rate of the US dollar should be left to the market on an urgent basis. It is not right to control the exchange rate of the US dollar in any way. Currently there are multiple exchange rates of the US dollar in the market, which cannot be desirable in any way. Bangladesh Bank may think that leaving the exchange rate of the US dollar to the market will lead to a massive depreciation of the local currency. This will increase import costs. There will be mass suffering. That's what economics says; But there is also the opposite. By fixing the exchange rate of the US dollar, in order to keep import costs at a bearable level, the supply of US dollars must be ensured according to the demand of the importers; But in the condition of Bangladesh Bank's foreign exchange reserves, Bangladesh Bank will not be able to provide sufficient amount of US dollars to the importers. Importers are not sitting in this situation. They are importing goods. By buying US dollars at higher prices from the kerb market, they are importing the goods and selling them at higher prices in the local market. As a result, the main purpose of fixing the exchange rate of the US dollar is being disrupted.

On the other hand, this initiative is having a negative impact on foreign exchange collection. At present, the price per US dollar sold in the banking channel is at least 12 to 15 taka lower than that in the kerb market. During normal times, there is a difference of Tk 1 to Tk 2 in exchange rate of US dollar in kerb market with banking channel. Due to getting 12 to 15 taka more than the banking channel in the kerb market, expatriate Bangladeshis are now gradually moving towards the kerb market. Last year, expatriate Bangladeshis sent 23 billion US dollars in remittances to the country. According to World Bank data, Bangladesh ranked seventh among remittance-receiving countries by receiving US$23 billion; But last year a record 13 lakh workers went abroad for employment. The remittances sent by expatriate Bangladeshis to the country during the recently concluded Ramadan month are less than the same period last year. This kind of incident happened for the first time. Does it mean that expatriate Bangladeshis have reduced remittances? No, they sent the remittance to the country properly. But he did it through Hundi. Expatriate Bangladeshis earn money by working hard. They will exchange or send foreign currency wherever they get more money in exchange for that money. Banks used to provide financial incentives at the rate of 2 percent in cash on expatriate income. Now the incentive rate has been raised to 5 percent. Even then, why all the remittances are not coming legitimately, have we thought about it? If Tk 115 available in banking channel for every US dollar with 5 percent financial incentive. If the same money is sent through hundi, at least 10 more taka are available. Who would want to lose this advantage? If the government could completely stop or strictly control the hundi trade, expatriates would send remittances through legal channels regardless of the foreign exchange rate; But is it possible? A bell must be tied around the horse's neck; But the question is, who will tie the bell?

If the foreign currency exchange rate were allowed to be determined by the market, it's estimated that the local currency would appreciate to around 128-129 taka for every US dollar. Such a move would likely incentivize expatriate Bangladeshis to send remittances through official channels. Mere words of encouragement are insufficient; actions speak louder than words, and people's allegiance may wane in the face of financial incentives.

Currently, remittances sent by expatriate Bangladeshis via informal channels, such as hundi, often find their way back abroad through various means. Many importers purchase USD at inflated rates from the kerb market to facilitate imports, while others exploit foreign currency for money laundering abroad. Allowing the US dollar exchange rate to be market-driven would encourage expatriates to send remittances through legitimate channels, thus bolstering Bangladesh Bank's reserves and mitigating the current reserve crisis significantly.

Furthermore, exporters often retain a substantial portion of their earnings abroad, anticipating a potential increase in the local market's US dollar exchange rate. Facilitating a market-driven exchange rate could incentivize them to repatriate these funds, thereby contributing to the country's economic stability and reducing reliance on external reserves.

Bangladesh Bank's initiative to identify willful defaulters is a commendable step towards ensuring accountability in the banking sector. However, the success of this initiative hinges on the abolition of various unethical benefits extended to defaulters in recent times.

Of particular concern is the opportunity provided to defaulters to reschedule loan accounts for a period of 10 years, with a one-year grace period and a mere 2 percent down payment. Such lenient terms only serve to embolden defaulters and undermine the integrity of the banking system. Cancelling these privileges is essential to uphold the principles of accountability and fairness.

Author: Retired General Manager, Bangladesh Development Bank Plc and Writer on Economic Affairs.