Will high inflation come under control anytime soon?

The current national budget has given special importance to controlling high inflation. Despite efforts over the past one and a half years, inflation remains unmanageable. The budget has set a target to bring down the inflation rate to 6.5% within the current fiscal year. However, most economists in the country believe this target is unattainable given the current state of the economy. They predict that even if inflation does not rise further, it is unlikely to fall below 9% anytime soon. Finance Minister Abul Hassan Mahmud Ali mentioned in a post-budget press conference that inflation would decrease within the next six months, but did not specify how this target would be achieved. A new monetary policy for the first six months of the current fiscal year is expected to be announced soon, and it is certain that controlling high inflation will be a priority. However, it is unlikely that inflation can be brought to a tolerable level through monetary policy alone.

The current high inflation is partly due to international events and partly due to our own unreasonable policies. Most of the initiatives taken to control inflation have failed because the policies were neither complete nor logical. After the Ukraine war post-COVID-19, global inflation surged, with the United States experiencing inflation at 9.1%, the highest in 40 years. An international organization analyzed the economies of 194 countries at that time and found that 179 of them faced high inflation. Some countries even experienced unbearable levels of inflation. A recent report indicates that most of these countries have now managed to bring inflation down to a tolerable level. According to the latest data, inflation in the United States has dropped to 3.4%. In economically troubled countries like Sri Lanka, inflation had exceeded 35% but is now below 4%.

The question is, how did these countries manage to reduce inflation so significantly? What measures did they take to control inflation? The US Federal Reserve, among other measures, increased the policy interest rate. Increasing the policy rate is one of the most straightforward ways to control high inflation, though it needs to be supplemented with other supportive measures. Let’s analyze how increasing the policy rate helps control high inflation. Scheduled banks borrow short-term loans from the central bank, and the interest rate charged by the central bank is known as the policy rate. The interest rate charged by scheduled banks to borrowers is known as the bank loan interest rate. The policy rate and the bank loan interest rate are interdependent. When the policy rate increases, the bank loan interest rate also increases proportionally to maintain the banks' profitability.

The policy rate can be adjusted under different names. If the central bank wants to reduce the money supply in the market, it increases the policy rate. Conversely, if it wants to increase the money supply, it decreases the policy rate. When the policy rate increases, scheduled banks have to pay higher interest rates to borrow from the central bank, which reduces their interest-related profits. Consequently, scheduled banks charge higher interest rates on loans to entrepreneurs and general borrowers, making loans more expensive. This reduces the tendency and capacity of people to take loans, decreasing the money supply in the market and gradually lowering inflation. However, increasing the policy rate also affects private sector investment and employment opportunities, but central banks still do it to relieve consumers from high inflation.

The US Federal Reserve has increased the policy rate at least 13 times in the last two years. Since US inflation is now at a manageable level, they are reconsidering further rate hikes. Following the US Federal Reserve, central banks in at least 77 other countries have also increased their policy rates and taken other measures to bring inflation down to tolerable levels. The Bangladesh Bank has also increased the policy rate several times to control high inflation. During the post-COVID-19 period, the policy rate in Bangladesh was 5%, and through several increments, it has now reached 8.5%. This means that previously, scheduled banks paid 5% interest to borrow from the Bangladesh Bank, but now they pay 8.5%. However, the Bangladesh Bank made a significant mistake by not allowing the bank loan interest rate to increase proportionally with the policy rate.

Until recently, the maximum interest rate on bank loans was fixed at 9%, meaning scheduled banks had to lend at 9% even if they borrowed at higher rates from the Bangladesh Bank. This made loans cheaper compared to inflation, and while scheduled banks were cautious about lending, they couldn't restrict influential borrowers. As a result, bank loan growth exceeded targets, while the import of raw materials and intermediate goods decreased by 14%, and capital machinery imports decreased by 76%. This discrepancy indicates that much of the loaned money went into the market, exacerbating inflation rather than reducing it. Some of this loaned money is also suspected to have been laundered abroad.

Later, when the interest rate on bank loans was increased, the flow of loans to the private sector decreased, with the latest figures showing private sector loan growth falling below 10%. However, the damage was already done. The Bangladesh Bank's mistake of capping the bank loan interest rate at 9% while increasing the policy rate harmed scheduled banks and market management. The substantial amount of loaned money that entered the market fueled inflation, the effects of which we are still dealing with. The question arises whether the Bangladesh Bank made an error or if certain groups manipulated the policy for their benefit. It is worth recalling that despite clear objections from economists and bank officials, the Bangladesh Bank set the maximum bank loan interest rate at 9% and the maximum deposit interest rate at 5.5% for state-owned banks and 6% for private banks. This decision was announced by the then-governor of the Bangladesh Bank at a meeting with businessmen and entrepreneurs in a hotel in the capital.

Another noteworthy point is the discrimination in setting the maximum deposit interest rate. For state-owned banks, the maximum deposit interest rate was set at 5.5%, while for private banks, it was set at 6%. This means a depositor would earn 5.5% interest in a state-owned bank and 6% interest in a private bank. Additionally, previously, state-owned institutions could keep up to 25% of their surplus deposits in private banks. This law was amended to allow private banks to hold up to 50% of the surplus deposits of state-owned institutions. Why does the Bangladesh Bank show such favoritism towards private banks?

In recent times, several laws and amendments related to the banking sector have been enacted with the intention of supporting loan defaulters. The latest initiative allows defaulters to exit by providing a 10% down payment, which has raised suspicions about its true purpose. Despite the government's efforts to reduce high inflation, there are groups actively trying to thwart these efforts. The cap on bank loan interest rates at 9% has harmed the banking sector, leading to higher inflation. Reducing this high inflation will take considerable time. Therefore, the goal of bringing the inflation rate down to 6.5% within the current fiscal year seems like a daydream.

In the past five years, the last two years have seen intolerably high inflation rates. The average inflation rate for the recently concluded fiscal year 2023-24 was 9.73%. The previous fiscal year, 2022-23, had an inflation rate of 9.02%. In the fiscal year 2021-22, it was 6.15%. In the preceding two years, the inflation rates were 5.56% and 5.65%, respectively, which can be considered tolerable.

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