—Niranjan Roy—

Monetary policy plays a crucial role in understanding the direction and momentum of any country’s economy. To assess the state of investment and where it is headed, one must carefully examine the declared monetary policy. However, monetary policy tends to work effectively only in economies where economic fundamentals are strong and the financial system is sufficiently mature. In countries where rules are followed, stakeholders respect regulations, and a quality financial system functions efficiently, monetary policy produces results.

Unfortunately, such conditions are largely absent in our economy. Instead, the country is plagued by a disorderly financial sector and a highly chaotic market system. As a result, the monetary policy announced by Bangladesh Bank rarely works as intended.

Every time Bangladesh Bank is about to announce its monetary policy, there is usually keen interest and discussion among economists, financial analysts, think tanks and the business community. This time, however, such interest has been noticeably absent.

There are several reasons for this. First, Bangladesh’s economy continues to face uncertainty and challenges, which are likely to persist this year as well. Second, the nation is currently in a transition phase, moving from one stage to another. Third, international and regional geopolitics are also experiencing significant instability. Fourth, several monetary policies adopted under the current governor have failed to deliver meaningful benefits.

Monetary policy primarily targets two fundamental objectives: controlling inflation and increasing employment. To achieve these goals, the policy interest rate is used as one of the central bank’s key tools. There is an inverse relationship between interest rates and investment—when interest rates rise, investment declines, and when interest rates fall, investment increases.

Investment and employment, on the other hand, share a supportive relationship. Increased investment leads to higher employment, thereby reducing unemployment. Conversely, higher interest rates discourage investment, reduce employment and ultimately increase unemployment. In short, interest rates, inflation, investment and employment are closely interlinked in the economy.

Why monetary policy needs to be eased

The policy interest rate is raised primarily to curb inflation. However, in Bangladesh, there are very few examples where inflation has been effectively reduced through interest rate hikes. Over the past one and a half years, Bangladesh Bank has raised the policy rate three times, taking it to 10%, yet inflation remains above 8% according to official figures. Unofficial estimates and real-life market experiences suggest inflation is even higher.

This is because inflation is influenced by both monetary and non-monetary factors. Monetary factors include the policy interest rate and money supply. Non-monetary factors include production systems, import costs, market structures, storage facilities, supply chains, distribution systems, hidden costs such as extortion, the absence of a standard pricing mechanism, consumers’ purchasing power and public awareness.

It goes without saying that none of these non-monetary factors are supportive in Bangladesh; rather, they are overwhelmingly adverse. Consequently, non-monetary factors have a far greater negative impact on inflation than monetary tools can offset. This is why Bangladesh Bank’s monetary policy—particularly the policy interest rate—has failed to control inflation.

While inflation has not come down despite the high policy rate, investment has suffered significantly, and businesses have been severely affected. Due to the elevated policy rate, bank lending rates now range between 15% and 17%. Investment under such high borrowing costs is simply not viable. At these rates, bank loans double roughly every five years, making repayment nearly impossible for most entrepreneurs. As a result, loans inevitably turn non-performing.

One of the key reasons behind Bangladesh’s massive volume of default loans is high interest rates. More importantly, high interest rates can sometimes increase inflation rather than reduce it, as businesses pass on their increased financial costs to consumers by raising product prices.

Bangladesh Bank has maintained a high policy rate for the past one and a half years, even as the global economy has entered a downward interest rate cycle. Over the past year, central banks in developed countries, as well as many developing nations, have cut policy rates multiple times. While Bangladesh’s policy rate stands at 10%, many developing and competitor countries—such as Vietnam and Indonesia—have rates ranging from 2.75% to 5.25%.

At a time when the world is moving towards lower interest rates, Bangladesh’s adherence to a high-rate regime is clearly counterproductive. In the interest of the national economy, alignment with global trade dynamics and encouragement of investment through business support, reducing the policy interest rate has become a necessity.

The country’s current political and economic landscape places Bangladesh Bank in a position where its scope for action is limited. However, one area where it can still act is by easing key monetary policy components, particularly the policy interest rate and money supply. Such steps would send a positive signal to investors and the business community—something that is urgently needed at this moment.

Although Bangladesh Bank has already announced its monetary policy, and major changes may not be feasible immediately, it can still take a policy decision to ease monetary conditions, especially by lowering the benchmark interest rate, through a post-policy notification. Such a move would bring much-needed relief to businesses.

It is hoped that Bangladesh Bank will consider the prevailing overall situation and move towards easing its declared monetary policy, with a reduction in the policy interest rate being a key step in that direction.

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The writer is a certified anti-money laundering specialist and banker based in Toronto, Canada.