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Table of Contents
Chapter 01 ..................................................................... 5
Introduction ................................................................... 5
1.1 Origin of the Report: ..................................................................................................................... 6
1.2 Objective of the Report:................................................................................................................ 7
1.3 Methodology of the Report: ......................................................................................................... 8
1.4 Limitation of the Report: ............................................................................................................... 9
Chapter 02 ................................................................... 10
Monetary Policy: An Overview .................................. 10
2.1 Definition: ................................................................................................................................... 11
2.2 History of Monetary Policy: ........................................................................................................ 11
2.3 Scope of Monetary Policy: .......................................................................................................... 12
2.4 Objectives of Monetary Policy: ................................................................................................... 12
2.5 Types of Monetary Policy ............................................................................................................ 13
2.6 Tools of Monetary Policy: ........................................................................................................... 15
Chapter 03 ................................................................... 16
Transmission Mechanism of Monetary Policy ........... 16
3.1 Transmission Mechanism of Monetary Policy: ........................................................................... 17
3.2 Understanding Overall Impact of Monetary Policy: Hypothetical Example ............................... 19
Chapter 4 ..................................................................... 21
Impacts of Monetary Policy ........................................ 21
4.1 Impacts of Monetary Policy: Perspective of Capital Market ...................................................... 22
4.1.1 Capital Market: ........................................................................................................................ 22
4.1.2 Impacts of Monetary Policy on Capital Markets: ..................................................................... 22
4.2 Impacts of Monetary Policy: Perspective of Inflation ................................................................. 23
Chapter 5 ..................................................................... 25
Monetary Policy Analysis: Bangladesh Experience ... 25
5.1: Background of Monetary Policy in Bangladesh: ........................................................................ 26
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5.2: Strategy of Monetary Policy in Bangladesh: .............................................................................. 27
5.3: Instruments of Monetary Policy in Bangladesh: ........................................................................ 29
5.4: Monetary policy Analysis in Bangladesh:................................................................................... 32
Chapter 6 ..................................................................... 36
Challenges of Establishing Monetary Policy in
Bangladesh .................................................................. 36
Challenges of Establishing Monetary Policy in Bangladesh: ............................................................. 37
Chapter 7 ..................................................................... 39
Overview of Monetary policy Statement (July-
December 2015) .......................................................... 39
Advocacy on Monetary Policy: Perspective of
Bangladesh .................................................................. 47
Conclusion: ................................................................. 48
Bibliography: .............................................................. 49
Websites: ..................................................................... 49
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Chapter 01
Introduction
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1.1 Origin of the Report:
Now a day’s education is not just limited to books and classrooms. In today’s world, education is the
tool to understand the real world and apply knowledge for the betterment of the society as well as
business. From education the theoretical knowledge is obtained from courses of study, which is only
the half way of the subject matter. Practical knowledge has no alternative. The perfect coordination
between theory and practice is of paramount importance in the context of the modern business world
in order to resolve the dichotomy between these two areas. Therefore, for the B.B.A. program we are
assigned to prepare a report on “Monetary Policy in Bangladesh” for F-208 Macroeconomics course.
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1.2 Objective of the Report:
This report is prepared on the very important issue in order to acquire the following objectives:
To relate the theoretical view with the practical view of insurance studies.
To increase our experience in data collection and analysis.
To know the actual condition of monetary policy of Bangladesh.
To know how different monetary tools control the market condition of Bangladesh.
To suggest of the findings.
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1.3 Methodology of the Report:
To prepare this report we mainly depend on secondary data. But also take some help from our course
instructor.
Procedure of collecting secondary data:
Records and documents.
Books, texts and publications.
Wikipedia.
Related Websites.
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1.4 Limitation of the Report:
While preparing this report, we have faced some problems. The main problem was to co-ordination all
the group members. Moreover, during data collection we faced several problems.
Due to limited access of the data, this study may not be perfect to the decent percent.
Lack of enough experience in analyzing of data.
Due to inadequate information, in-depth analysis could not be done in the report.
Lack of using practical knowledge in the report
For that reason it was pretty much contradictory. We tried to write the report in a sequential way but
there may be some problems in the sequence of the report. But all these errors are totally
unintentional. At the end we are very happy to present this report to the readers and its success will
depend on the positive response of the readers.
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Chapter 02
Monetary Policy: An Overview
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2.1 Definition:
In simple words monetary policy is the branch of macroeconomic policy laid by the central bank. This
policy undertaken by central bank basically controls the money supply to maintain a healthy
economic growth. Monetary policy can also be called a process by which the monetary authority of a
country controls the supply of money; often targeting a rate of interest for the purpose of promoting
economic growth and stability. The official goals usually include relatively stable prices and low
unemployment. Monetary theory provides insight into how to craft optimal monetary policy.
Monetary policy is the process by which the government, central bank, or monetary authority of a
country controls:
the supply of money,
availability of money, and
Cost of money or rate of interest to attain a set of objectives oriented towards the growth and
stability of the economy.
Monetary theory provides insight into how to craft optimal monetary policy.
2.2 History of Monetary Policy:
In the following there is a brief history of monetary policy:
2.2.1 Early Period:
Monetary policy is associated with interest rates and availability of credit. Instruments of monetary
policy have included short-term interest rates and bank reserves through the monetary base. For many
centuries there were only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to
print paper money to create credit. Interest rates, while now thought of as part of monetary authority,
were not generally coordinated with the other forms of monetary policy during this time.
2.2.2 Origination of Paper Money:
Paper money called "jiaozi" originated from promissory notes in 7th century China. Jiaozi did not
replace metallic currency, and were used alongside the copper coins. The successive Yuan Dynasty
was the first government to use paper currency as the predominant circulating medium. In the later
course of the dynasty, facing massive shortages of specie to fund war and their rule in China, they
began printing paper money without restrictions, resulting in hyperinflation.
2.2.3 Origination of Central Bank:
With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and
back them with gold, the idea of monetary policy as independent of executive action
began to be established. The goal of monetary policy was to maintain the value of the coinage, print
notes which would trade at par to specie, and prevent coins from leaving circulation.
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2.2.4 Industrialization Period:
During the 1870–1920 period, the industrialized nations set up central banking systems, with one of
the last being the Federal Reserve in 1913. By this point the role of the central bank as the "lender of
last resort" was understood. It was also increasingly understood that interest rates had an effect on the
entire economy, in no small part because of the marginal revolution in economics, which
demonstrated how people would change a decision based on a change in the economic trade-offs.
Monetarist economists long contended that the money-supply growth could affect the macro
economy. This is how the monetary policy has gradually developed over the period and has now
become a useful tool to maintain macroeconomic balance.
2.3 Scope of Monetary Policy:
Monetary decisions today take into account a wider range of factors, such as:
Short term interest rates;
Long term interest rates;
Velocity of money through the economy;
Exchange rates
Credit quality
Bonds and equities (corporate ownership and debt)
Government versus private sector spending/savings
International capital flows of money on large scales
Financial derivatives such as options, swaps, futures contracts, etc.
2.4 Objectives of Monetary Policy:
The objectives of a monetary policy aim at growth, stability and social justice. After the Keynesian
revolution in economics, many people accepted significance of monetary policy in attaining some
crucial objectives. These are the general objectives which every central bank of a nation tries to attain
by employing certain tools (Instruments) of a monetary policy. Let us now see objectives of monetary
policy in detail:
Rapid Economic Growth:
It is the most important objective of a monetary policy. The monetary policy can influence economic
growth by controlling real interest rate and its resultant impact on the investment.
Price Stability:
The monetary policy having an objective of price stability tries to keep the value of money stable. It
helps in reducing the income and wealth inequalities.
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Exchange Rate Stability:
Exchange rate is very volatile leading to frequent ups and downs in the exchange rate; the
international community might lose confidence in our economy. The monetary policy aims at
maintaining the relative stability in the exchange rate.
Balance of Payments (BOP) Equilibrium:
The central bank through its monetary policy tries to maintain equilibrium in the balance of payments.
The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. If the monetary policy succeeds
in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.
Full Employment:
Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does
not mean that there is a zero unemployment. In that senses the full employment is never full.
Monetary policy can be used for achieving full employment. If the monetary policy is expansionary
then credit supply can be encouraged. It could help in creating more jobs in different sector of the
economy.
Neutrality of Money:
The monetary policy should regulate the supply of money. The change in money supply creates
monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the
effect of money expansion.
Equal Income Distribution
Monetary policy can make special provisions for the neglect supply such as agriculture, small-scale
industries, village industries, etc. and provide them with cheaper credit for longer term. This can
prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in
reducing economic inequalities among different sections of society.
2.5 Types of Monetary Policy:
There are mainly to types of monetary policy. They are:
1) Expansionary policy
2) Contractionary policy
1) Expansionary Policy:
Expansionary monetary policy is appropriate when the economy is in recession and unemployment is
a problem. The goal of expansionary monetary policy is to reduce unemployment. Therefore the tools
would be an increase in the money supply.
To increase the money supply the government can:
Buy government bonds (open market purchase)
Lower the interest rate
Lower the reserve ratio
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2) Contractionary Policy:
Contractionary monetary policy is appropriate when economy is in expansion and inflation is a
problem. The goal of contractionary monetary policy is to reduce inflation. Therefore the tool would
be the decrease in the money supply.
To decrease the money supply the government can:
Sell government bonds (an market sell)
Raise the interest rate
Raise the reserve ratio
There are other various types of monetary policy lies primarily with the set of instruments and target
variables that are used by the monetary authority to achieve their goals. They are:
Inflation Targeting:
The inflation target is achieved through periodic adjustments to the Central Bank interest rate target.
The interest rate used is generally the overnight rate at which banks lend to each other overnight for
cash flow purposes. Depending on the country this particular interest rate might be called the cash rate
or something similar.
Price Level Targeting:
Price level targeting is a monetary policy that is similar to inflation targeting except that CPI growth
in one year over or under the long term price level target is offset in subsequent years such that a
targeted price-level is reached over time, e.g. five years, giving more certainty about future price
increases to consumers.
Monetary Aggregates:
While monetary policy typically focuses on a price signal of one form or another, this approach is
focused on monetary quantities. As these quantities could have a role on the economy and business
cycles depending on the households' risk aversion level, money is sometimes explicitly added in the
central bank's reaction function. This approach is also sometimes called monetarism.
Fixed Exchange Rate:
This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying
degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate
is with the anchor nation.
Gold Standard:
The gold standard is a system under which the price of the national currency is measured in units of
gold bars and is kept constant by the government's promise to buy or sell gold at a fixed price in terms
of the base currency. The gold standard might be regarded as a special case of "fixed exchange rate"
policy, or as a special type of commodity price level targeting.
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2.6 Tools of Monetary Policy:
To accomplish its monetary policy objective, the Central Bank of a country can use a mix of direct
and indirect policy tools to influence the supply and demand of money.
2.6.1 Direct Policy Tools:
These tools are used to establish limits on interest rates, credit and lending. These include direct credit
control, direct interest rate control and direct lending to banks as lender of last resort, but they are
rarely used in the implementation of monetary policy by the Bank.
Interest Rate Controls: The central bank has the power to announce the minimum and
maximum rates of interest and other charges that domestic banks may impose for specific
types of loans, advances or other credits and pay on deposits.
Credit Controls: The central bank has the power to control the volume, terms and conditions
of domestic bank credit, including installment credit extended through loans, advances or
investments.
Lending to Domestic Banks: The central bank may provide credit, backed by collateral,
to domestic banks to meet their short-term liquidity needs as lender of last resort. The interest
is set at a punitive rate to encourage banks to manage their liquidity efficiently.
2.6.2 Indirect Policy Tools:
Used more widely than direct tools, indirect policy tools seek to alter liquidity conditions. While the
use of reserve requirements has been the traditional monetary tool of choice, more recently, the Bank
also shift towards the use of open market operations to manage liquidity in the financial system and to
signal its policy stance.
Reserve Requirements: The central bank uses reserve requirements to limit the amount of
funds that domestic banks can use to make loans to its customers. Domestic banks are
required to hold a proportion of customers’ deposits in approved liquid assets. An increase in
the reserve ratios should reduce domestic banks’ lending and, therefore, the demand for hard
currency, while a decrease should yield the opposite effect.
Secondary Reserve Requirement: This is a certain percentage of domestic banks’ deposit
liabilities that is to be held in approved liquid assets. It should be freely and readily
convertible into cash without significant loss, free from any charge, lien or encumbrance.
Cash Reserve Requirement: also called primary reserve requirements, is a percentage
of domestic banks’ average deposit liabilities that must be held at the Bank in a non-interest
bearing account. Cash reserves are a component of the secondary reserve requirements.
Securities Requirement: To encourage the development of the government securities
market, a securities requirement is required for domestic banks to hold a proportion of their
average deposit liabilities in the form of Treasury bills. The securities requirement is also a
component of the secondary reserve requirements.
Open Market Operations: The conduct of open market operations refers to the purchase or
sale of government securities by the central bank to the banking and non-banking public for
liquidity management purposes. When the Bank sells securities, it reduces domestic banks’
reserves (monetary base), and when it buys securities, it increases banks’ reserves.
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Chapter 03
Transmission Mechanism of Monetary Policy
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3.1 Transmission Mechanism of Monetary Policy:
This is the process through which monetary policy decisions affect the economy in general and the
price level in particular. The transmission mechanism is characterized by long, variable and uncertain
time lags. Thus it is difficult to predict the precise effect of monetary policy actions on the economy
and price level.
The chart below provides a schematic illustration of the main transmission channels of monetary
policy decisions.
Fig 3.1: Transmission Mechanism of Monetary Policy
3.1.1 Change in Official Interest Rates:
The central bank provides funds to the banking system and charges interest. Given its monopoly
power over the issuing of money, the central bank can fully determine this interest rate.
3.1.2 Affects Banks and Money Market Interest Rates:
The change in the official interest rates affects directly money-market interest rates and, indirectly,
lending and deposit rates, which are set by banks to their customers.
Changes in Risk
Premium
Changes in Bank
Capital
Changes in Global
Economy
Changes in Fiscal
Policy
Changes in
Commodity
Prices
Official Interest Rates
Expectations Money Market
Interest Rates
Money
Credit
Asset
Prices
Bank
Rates
Exchange
Rates
Wage and
Price Setting
Supply and Demand in Goods
and Labour Markets
Domestic Prices Import
Prices
Price Developments
Shocks outside the
Control of the
Central Bank
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3.1.3 Affects Expectations:
Expectations of future official interest-rate changes affect medium and long-term interest rates. In
particular, longer-term interest rates depend in part on market expectations about the future course of
short-term rates.
Monetary policy can also guide economic agents’ expectations of future inflation and thus influence
price developments. A central bank with a high degree of credibility firmly anchors expectations of
price stability. In this case, economic agents do not have to increase their prices for fear of higher
inflation or reduce them for fear of deflation.
3.1.4 Affects Asset Prices:
The impact on financing conditions in the economy and on market expectations triggered by monetary
policy actions may lead to adjustments in asset prices (e.g. stock market prices) and the exchange rate.
Changes in the exchange rate can affect inflation directly, insofar as imported goods are directly used
in consumption, but they may also work through other channels.
3.1.5 Affects Saving and Investment Decisions:
Changes in interest rates affect saving and investment decisions of households and firms. For
example, everything else being equal, higher interest rates make it less attractive to take out loans for
financing consumption or investment.
In addition, consumption and investment are also affected by movements in asset prices via wealth
effects and effects on the value of collateral. For example, as equity prices rise, share-owning
households become wealthier and may choose to increase their consumption. Conversely, when
equity prices fall, households may reduce consumption.
Asset prices can also have impact on aggregate demand via the value of collateral that allows
borrowers to get more loans and/or to reduce the risk premium demanded by lenders/banks.
3.1.6 Affects the Supply of Credit:
For example, higher interest rates increase the risk of borrowers being unable to pay back their loans.
Banks may cut back on the amount of funds they lend to households and firms. This may also reduce
the consumption and investment by households and firms respectively.
3.1.7 Leads to Changes in Aggregate Demand and Prices:
Changes in consumption and investment will change the level of domestic demand for goods and
services relative to domestic supply. When demand exceeds supply, upward price pressure is likely to
occur. In addition, changes in aggregate demand may translate into tighter or looser conditions in
labour and intermediate product markets. This in turn can affect price and wage-setting in the
respective market.
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3.1.8 Affects the Supply of Bank Loans:
Changes in policy rates can affect banks’ marginal cost for obtaining external finance banks
differently, depending on the level of a bank’s own resources, or bank capital. This channel is
particularly relevant in bad times such as a financial crisis, when capital is scarcer and banks find it
more difficult to raise capital.
In addition to the traditional bank lending channel, which focuses on the quantity of loans supplied, a
risk-taking channel may exist when banks’ incentive to bear risk related to the provision of loans is
affected. The risk-taking channel is thought to operate mainly via two mechanisms. First, low interest
rates boost asset and collateral values. This, in conjunction with the belief that the increase in asset
values is sustainable, leads both borrowers and banks to accept higher risks. Second, low interest rates
make riskier assets more attractive, as agents search for higher yields. In the case of banks, these two
effects usually translate into a softening of credit standards, which can lead to an excessive increase in
loan supply.
3.2 Understanding Overall Impact of Monetary Policy: Hypothetical
Example
Suppose a person check the BB website on the first Tuesday of the month, and find the Bank plans to
repurchase $100 million worth of financial securities the following day.
Let’s we find the consequence of this policy taken by Bangladesh Bank by answering the following
four questions:
i. What changes can be occurred regarding the current state of the Bangladesh economy?
ii. What impact does the Bangladesh Bank Board hope this action will have on the real
economy?
iii. What change will occur in the consumer’s borrowing and spending pattern?
iv. What will be the position of aggregate demand, GDP and the price level?
Solution to the Problem:
Changes in the Bangladesh Economy:
A repurchase of financial securities by the Bangladesh Bank will increase the cash reserves of the
banking sector, decreasing the demand for overnight loans between financial institutions and hence
the decreasing the cash rate.
In other words, the BB is conducting an expansionary monetary policy, which suggests growth in the
Bangladesh economy is slowing.
Changes in the Real Economy:
The repurchase of financial securities will-
1. Inject funds into commercial banks, which will result in a fall in the cash rate.
2. This fall in the cash rate will typically flow through to all interest rates throughout the
financial sector.
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3. As a result, firms and consumers can borrow and hence spend more.
Changes in the Consumer’s Borrowing and Spending:
This repurchase of securities by BB will help people to borrow and spend more.
Changes in the Aggregate Demand, GDP and Price Level:
Aggregate demand will then move outwards to the right by more than it would have without policy,
GDP will increase, as will the price level.
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Chapter 4
Impacts of Monetary Policy
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4.1 Impacts of Monetary Policy: Perspective of Capital Market
4.1.1 Capital Market:
A capital market is a market for securities (debt or equity), where business enterprises and
governments can raise long-term funds. It is defined as a market in which money is provided for
periods longer than a year, as the raising of short-term funds takes place on other markets (the money
market). The capital market includes the stock market (equity securities) and the bond market (debt).
4.1.2 Impacts of Monetary Policy on Capital Markets:
Impacts of monetary policy on capital market can be examined through taking consideration of the
following two situations of monetary policy. Viz:
(i) Impacts in Case of Expansionary policy
(ii) Impacts in Case of Contractionary policy
i) Impacts in Case of Expansionary policy:
In any country, when the central bank wishes to increase the money supply, it can do a combination of
three things:
(i) Purchase securities on the open market, known as Open Market Operations
(ii) Lower the central bank’s Discount Rate
(iii) Lower Reserve Requirements
These all directly impact the interest rate.
Explanation:
When the central bank buys securities on the open market, it causes the price of those securities to
rise. We know that bond prices and interest rates are inversely related. The central bank’s discount
Rate is an interest rate, so lowering it is essentially lowers interest rates.
If the central bank instead decides to lower reserve requirements, this will cause banks to have an
increase in the amount of money they can invest. This causes the price of investments such as bonds
to rise, so interest rates must fall. No matter what tool the central bank uses to expand the money
supply, interest rates will decline and consequently bond prices will rise.
Increases in bond prices will have a negative effect on the capital market. Rising bond prices will
cause investors to sell those bonds in exchange for other bonds such as foreign bonds.
Summary of the Explanation:
1. Expansionary monetary policy causes an increase in bond prices and a reduction in
interest rates.
2. Lower interest rates lead to higher levels of capital investment.
3. The lower interest rates make domestic bonds less attractive, so the demand for domestic
bonds falls and the demand for foreign bonds rises.
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4. The demand for domestic currency falls and the demand for foreign currency rises,
causing a decrease in the exchange rate.
ii) Impacts in Case of Contractionary policy:
The effects of a contractionary monetary policy are precisely the opposite of an expansionary
monetary policy. In the any country, when the central bank wishes to decrease the money supply, it
can do a combination of three things:
a) Sell securities on the open market, known as Open Market Operations
b) Raise the central bank’s Discount Rate
c) Raise Reserve Requirements
Explanation:
These cause interest rates to rise, either directly or through the increase in the supply of bonds on the
open market through sales by the central bank or by commercial banks. This increase in supply of
bonds reduces the price for bonds.
Summary of the Explanation:
1. Contractionary monetary policy causes a decrease in bond prices and an increase in interest
rates.
2. Higher interest rates lead to lower levels of capital investment.
3. The higher interest rates make domestic bonds more attractive, so the demand for domestic
bonds rises and the demand for foreign bonds falls.
4. The demand for domestic currency rises and the demand for foreign currency falls, causing an
increase in the exchange rate.
4.2 Impacts of Monetary Policy: Perspective of Inflation
Monetary policy is the process by which the monetary authority of a country controls the supply of
money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the
currency. On the other hand, inflation is a sustained increase in the general price level of goods and
services in an economy over a period. We have already discussed about tools of monetary policy.
Inflation rate is also influenced by formulation of monetary policy tools.
1. Impact of Interest Rate: When Bangladesh Bank decreases interest rate; more people are
able to borrow more money. The result is that consumers have more money to spend, causing
the economy to grow and inflation to increase. As interest rates are increased, consumers tend
to have less money to spend. With less spending, the economy slows and inflation decreases.
2. Impact of Cash Reserve Requirements: If Bangladesh Bank increases Cash reserve
requirements of commercial bank then it reduces the money stock. As result, cost of credit
rises and consumers trend to have less money to spend. With less spending, the inflation
decreases. On the other hand, If Bangladesh Bank decreases reserve requirements of
commercial bank, the consumers have to more money to spend and inflation increases.
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3. Impacts of Open Markets Operation: If Bangladesh Bank purchase security from public
and commercial banks, the money supply will increase in the market. As a result, inflation
will also increase. On the other hand, If Bangladesh Bank sells security to public and
commercial bank, the money supply will decrease in the market and falls inflation rate.
4. Impacts of Securities Requirements: If Bangladesh Bank increases securities requirements
for domestic commercial bank, the money supply will decrease in the market. As a result,
consumers have less money to spend and inflation decreases. On the other hand, if
Bangladesh Bank decreases securities requirements for domestic commercial bank, the money
supply will increase in the market. As a result, inflation rate will also increase.
5. Impacts of Statutory Liquidity Requirements: If Bangladesh Bank increases statutory
liquidity requirements for domestic commercial banks, the money supply will decrease in the
market. As a result, consumers have less money to spend and inflation rate decreases. On the
other hand, if Bangladesh Bank decreases statutory liquidity requirements for domestic
commercial bank, the money supply will increases in the market and inflation rate will also
increase.
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Chapter 5
Monetary Policy Analysis: Bangladesh Experience
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5.1: Background of Monetary Policy in Bangladesh:
The policy adopted by the central bank for control of the supply of money as an instrument for
achieving the objectives of general economic policy. As stated in the Bangladesh Bank order 1972,
the principal objectives of the countries monetary policy are to regulate currency and reserves. To
manage the monetary and credit system; to preserve the par value of domestic currency ; to promote
and maintain a high level of production, employment and real income ; and to foster growth and
development of the country’s productive resources in the best national interest. Although the long
term focus of monetary policy in Bangladesh is on growth with stability, the short term objectives are
determined after a careful and realistic appraisal of the current economic situation of the country.
The monetary policy works in a schematic diagram that has a notice worthy tradeoffs amongst the
concerned variables. Here, in the aspect of Bangladesh, the schematic diagram representing the
monetary policy transmission mechanism is described in the following chart:
Figure 5.1: Schematic Diagram Representing the Monetary Policy Transmission Mechanism
With the shift of the policy stance of the government in various phases, necessary adjustments were
made in the country’s monetary policy in the first year after liberation, the primary target of monetary
policy was to regulate not the quantity of money, but the direction of the flow of money and in
support of the government financial programmed. In 1975, Bangladesh entered in to a standby-
arrangement with IMF and the country’s monetary policy got a changed shape, which fixed an
explicit target to save limit of monetary expansion on annual basis, with this change, Bangladesh
Bank started setting short-term objectives of monetary policy in close collaboration of the government
and tried to achieve the target by using the direct instrument of control. The principal target of
monetary control was broad money (M2) i.e. the sum of the currency in circulation and the total
deposits of money in banks. The targeted growth of M2 depended on a realistic forecast of the growth
rate of real GDP, an acceptable rate of inflation and an attainable level of international reserve.
Bangladesh Bank took majors to monitor credit and monetary expansion keeping in view with the
price situation and international reserve position. Efforts were made to achieve the targeted growth of
domestic credit and thereby, the money supply, through imposing ceiling on credit to the government,
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public and private sector. The major policy instrument available to Bangladesh Bank and provide
liberal refinance facility at confessional rate for priority lending. According to the national economic
policy, the Banks were to provide the desired volume of credit and administered a low rate of interest.
In that situation, Bangladesh Bank practically did not have any effective instrument for making
adjustment in the growth of money supply or for transmitting market signals into changes in money
supply. The monetary policy therefore, could not function in true sense as a result the banking system
could not play its role as an effective financial intermediary. (“Central Banking in the New
Millennium." Ahluwalia,)
5.2: Strategy of Monetary Policy in Bangladesh:
The MPS (Monetary Policy Statement) starts with expression of the monetary policy frameworks in
terms of the goals, instruments, and the channels of transmission. Maintaining price stability while
supporting the highest sustainable output growth is the stated objective of monetary policies pursued
by the Bangladesh Bank.
5.2.1: Frameworks of Bangladesh’s Monetary Policy:
The framework of monetary policy in Bangladesh set out below:
Figure 5.2: Frameworks of Bangladesh’s Monetary Policy
5.2.1.1: The Policy Target:
In this backdrop it is necessary that the monetary policy framework (in terms of the goals, the
instruments, and the analytic channels of transmission) be articulated for greater clarity and
transparency benefiting both the policy makers as well as the stakeholders. A policy system, where
the goals are transparent and their achievement verifiable, directly adds to the credibility of the central
bank, a major objective of this document is to define such a framework. Most industrial economy
monetary policy is run with the task of keeping watch on both the output gap (i.e., the deviation of
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actual output from its long-run equilibrium level) and the inflation gap, which is similarly defined. In
contrast, however, the challenge in the developing world is how to augment the capacity output
through both productivity growths as well as via the installation of additional capacity. Faster growth
in most developing contexts is necessary to reduce (and eventually eliminate) common poverty.
Hence the appropriate monetary policy strategy in the Bangladesh context would be to achieve the
goal of price stability with the highest sustainable output growth.
Any monetary stimulus to promote growth must keep in perspective the broader goal of
macroeconomic stability, which is a prerequisite for future growth. Price stability would also include
the stability of the currency regime. While fiscal policy too is relevant in addressing these goals and
thus there is a need for policy coordination, monetary policy must play its due role. While leading
central banks in the industrial world have increasingly adopted the unitary goal of fighting inflation,
interestingly directive by enumerating-
The promotion of price stability.
Ensuring full employment.
Supporting global economic and financial stability (so long as the latter maybe targeted
without prejudicing the first two goals) as the chief monetary policy goals.
In broad terms therefore, the latter view is consistent with the BB’s vision as enunciated above,
although anchored along different perspectives.
5.2.1.2: Inflation Target:
It is the general wisdom that monetary policy tools are of immediate influence in controlling inflation.
However contemporary evidence amply illustrates that monetary policy cannot deal well with the
inflationary impact of external shocks such as the recent international price of oil and related energy
products. Many central banks as a consequence focus on the core inflation, which is typically
constructed by subtracting the most volatile components (e.g., food and energy prices, indirect taxes
etc) from the consumer price index (CPI). The Bank of Canada argues that it is the core concept that
better predicts the underlying price stability in the economy. Hence as a policy goal, core inflation
may be a more credible target than CPI inflation. While there is no standard measure of core inflation
in the Bangladesh context at this time, the construction methodology is made complex by two facts.
First is that food items constitute nearly 60 percent of the CPI index, and while the appropriate
commodity group weights may require a re-think, to ignore food entirely in defining the core inflation
may render the construction a bit like throwing the baby away with the bath water. Secondly, in the
Bangladesh context, the volatility of the international energy prices appear not to filter down to the
CPI since the relevant domestic prices is subsidized by the state. Periodic adjustments in administered
energy prices have always lagged the world market changes in both the time line as well as in
magnitude often most dramatically. While it may be useful to focus on the non-food component of the
index (which occupies only 41.6 percent of the full CPI) in order to gauge at the build-up of
underlying inflationary forces in the economy, it would be unwise to treat this alone as a valid
measure of core inflation.
5.2.1.3: Growth Target:
GDP growth projections of the Medium Term Macroeconomic Framework (MTMF) in the
government's National Strategy for Accelerated Poverty Reduction (NSAPR), modified appropriately
in the light of unfolding actual developments, are used as output growth targets for the purpose of
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monetary policies. (National Policy Forum Dhaka: 20-22 August, 2009 Organized by: Centre for
Policy Dialogue, Prothom Alo, The Daily Star,)
5.3: Instruments of Monetary Policy in Bangladesh:
In 1989, the government adopted a comprehensive Financial Sector Reform Programmed (FSRP),
following which the country's monetary policy assumed a new orientation towards promotion of
market economy in a competitive environment. Bangladesh Bank started moving away from direct
quantitative monetary control to indirect methods of monetary management since the beginning of
1990. Although, the fixation of target continued to remain as the central piece of exercise, the way to
achieve it had been changed. Credit ceilings on individual banks and direct controls of interest rates
were withdrawn. At present, the money supply is regulated through indirect manipulation of reserve
money instead of credit ceiling. Major instruments of monetary control available with Bangladesh
Bank are the bank rate, open market operations, rediscount policy, and statutory reserve requirement.
5.3.1: The methods of Credit Control:
The methods of credit control can be classified as follows:
5.3.1.1: Quantitative Methods:
The quantitative methods required for credit control are as follows. These are also called the
conventional methods of credit control.
Bank rate policy
Open market policy
Variation of reserve ratio
5.3.1.2: Qualitative Methods:
The qualitative methods required for credit control are as follows. These are most decentralized and
situation based credit control policies.
Rationing of credit
Direct action
Regulation of consumers’ credit
Moral persuasion
Publicity
The methods of credit control are described below:
Quantitative Methods:
The methods by which Central Bank controls the total amount of credit in theeconomy are termed as
quantitative methods of credit control.
a) Bank Rate Policy:
The rate which central bank lends money to the commercial banks and discounts bill of exchange is
called bank rate. If central bank increases the bank rate then the commercial banks will increase their
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marker of interest rates. As a result the borrowers borrow less form commercial banks and amount of
credit reduces in the economy. In an opposite way amount of credit will be increased in the country.
Effects:
Effects on price level: If bank rate increases, cost of credit will increase and the businessmen will
reduce their borrowing s form commercial banks. This will reduce production and increase
unemployment in the economy. As a result, income and price level will go down and depression in
business and trade will be the outcome. If there is a decrease in the bank rate the opposite e results of
above will be experienced in the economy.
Effects on Foreign Trades:
An increase in bank rate wills increases other interest rates in the country. So, investment will be
profitable. It will ensure the insertion of foreign capital into the economy and leakage of domestic
capital will be stopped. Moreover, increased bank rate will decrease the piece level because amount of
credit will be reduced into country. This decreased price level will again encourage expert and
discourage import, which will make balance of payment favorable. Opposite effects of above will be
experienced if the central bank decreases the bank rate in the economy.
Limitations of Bank Rate Policy:
Bank rate policy would not be effective if there lacks strong linkage between bank rate and
market/ interest rate especially for a developing country like Bangladesh.
If commercial banks have excessive money; then bank rate may not be effective because they
will lend in lower interest rates though bank rate increases.
Bank may successes during the time of prosperity. Because businessmen become highly
ambitious of their profits in this situation and will borrow money, though the interest rate is
high.
Reduction in bank rate may not be successful to increase the amount of credit during the time
of depression. So, bank rate policy has several limitations in its operation. After that it is the
best weapon of central bank to control the amount of credit in the economy.
b) Open Market Policy:
The method by which the central bank controls the amount of credit by selling and buying
government credit instrument is termed as open market operation. When the central bank intends to
contract credit, it sales the credit instruments in the market. These instruments are purchased by
commercial banks and people also buy them issuing cheque to the commercial banks. Thus money
goes to the central bank and amount of money for credit creation reduces which in turn contracts the
amount of credit in the economy.
Limitations of Open Market Policy:
Selling- it reduces amount of cash of commercial banks .but if commercial banks take loan
form central bank it would not be effective to reduce credit.
Buying- it increases the amount of cash in commercial banks. But it may not be able to
expand credit if commercial banks repay loan to the central bank with this increased cash.
Depreciation- During depreciation, credit expansion through purchasing credit instruments is
not possible.
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c) Variation of Reserve Ratio
Each commercial bank has to keep legally a certain portion of its total deposits as reserve with central
bank. This is called reserve ratio. If central bank increases this reserve ratio, excess reserve in
commercial banks will reduce and thus credit creation will be contracted in the economy. In an
opposite way central bank can increase the amount of credit by decreasing the reserve ratio.
Limitations:
Increase in reserve ration can be effective for that commercial bank having small amount of
cash. Because bank having large volume of cash will have sufficient excess reserve to create
credit though reserve ration increases. In this case it will not be effective.
Decrease in reserve ration may not be effective to expand credit during depression
businessmen are discouraged to borrow in this situation.
Non-scheduled commercial banks are out of this control.
Qualitative Methods:
The methods used to control credit in special sectors for special purposes are called
qualitative\selective methods of credit control. These methods do not deal with the amount of credit
rather change the flow or direction of credit used in different sectors of economy.
a) Rationing of credit
Rationing of credit means fixing the amount of credit among different sectors of the economy. By this
method central bank can decrease the amount of credit in one sector and can increase it in other
sector. For example, if central bank thinks that there is excessive investment in garments industry and
jute industry suffers form required investment, then it can order the commercial banks not to disburse
credit beyond required amount in garments industry and divert the excess amount to jute industry.
Limitations
Borrowers may use the credit money in other purposes.
It is difficult for central bank to supervise whether the credit money is being used purposively
or not.
Sometimes commercial banks think this type of work as an unwanted intervention by central
bank.
b) Direct Action:
If it is proved by central bank that credit creation policy of any commercial bank is not transparent
then central bank can take punitive measures against that bank and thus affects its credit creation.
These punitive measures may be of not rediscounting bills of exchange, discounting bills of exchange
at a rate higher than the prevailing rare, etc. As a result, the commercial bank will compelled to follow
sound central bank policy.
c) Regulation of Consumers’ Credit:
It is a method to control credit in consumable goods, which are purchased in installment basis. If
central bank circulates to increase the amount of down payment or reduce the number of installment
then consumer’ credit will be contracted in the economy. In an opposite way consumers’ credit can be
increased. It was followed in USA during Korean War.
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d) Moral Persuasion:
To make the banking system sound and efficient, central bank sometimes requests the commercial
banks to increase or decrease credit. As a guardian’s request, commercial banks follow it and thus
amount of credit is controlled in the economy.
e) Publicity:
Sometimes central bank applies publicity as a weapon of credit control. Central bank publishes
weekly, fortnightly or monthly bulletins and annual reports where balance sheets and other business
and economic condition of different commercial banks are presented well. As a result the commercial
banks become more careful in the line of their credit creation. Thus central bank applies various types
of measures to control credit in the economy. But central bank should apply different types of method
simultaneously rather to use single method to make credit control effective. (Bangladesh Bank
Working Paper Series: WP 0708, 2007).
5.4: Monetary policy Analysis in Bangladesh:
On the basis of previous year’s judgments of monetary policies, in the report, the trend of monetary
policies taken by BB has been analyzed in the next chapter. In this chapters till the previous year
2014, the summarizing analyses have been shown that is mandatory for comparative analysis and
show srenghts and weakness of the monetary policy in Bangladesh.
In its Monetary Policy Statement (MPS) for January-June 2014, Bangladesh Bank decided to observe
a cautious monetary policy and keep the repo rate unchanged at 7.25%3. While year-over-year (YoY)
inflation was quite high at 7.35%, Bangladesh Bank was of the opinion that monetary stimulus would
not be needed to revive economic activity as there was more than enough liquidity in the economy. In
addition, Bangladesh Bank was keener on easing the difficulties faced by industries hurt by political
trouble than providing broader monetary stimulus. According to BRAC EPL4, the banking sector
interest rates would continue to come down in the absence of any sign.ificant real credit demand,
eliminating the need for further monetary easing. Investors would look to grow their equity assets as
rates for fixed income securities were coming down and the real estate market continued to remain
stagnant. Due to the large amount of liquidity in the banking sector, a monetary stimulus would not
have much impact on the broader economy or the capital market. Interest rates were likely to decline
as credit growth in calendar year 2014 was expected to be lower than deposit growth. Monetary policy
as such was unlikely to drive the market. Any market activity would be caused by political
developments and businesses' earnings power of monetary policy taken by BB, the estimation has
been done in the next chapter of the report.
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Table: Monetary Policy Summary till FY 2014
Bangladesh Bank's monetary stance would aim to reduce average inflation down to the target of 7%
by ensuring monetary growth while ensuring that there was sufficient credit growth to stimulate
inclusive economic growth. According to Lanka Bangla Securities, however, the policy remained a
neutral one.
Figure 5.3: Target vs. Current Status Figure5.4: Inflation (2005/06base year)
Increased food inflation can be attributed to the higher distribution costs caused by nationwide strikes,
as well as rising food inflation in India (considered highly correlated to local food inflation).
Conversely, non-food inflation declined due to lower consumer demand amid the economic slowdown
caused by the strikes and blockades. This led to a net increase in average inflation (up from 6.06%).
Bangladesh Bank's attempt to lower inflation to its target of 7% was expected to be countered by an
expected surge in aggregate demand in the second half of FY14, resulting from a likely improvement
in political stability. Low government borrowing (BDT 46 million against target of BDT 260 million)
was attributed to the increase in revenue from the sales of national savings certificates and slow
implementation of the Annual Development Program. BB's monetary stance for the second half of
FY14 assumed that the government borrowing would hit the BDT 260 million targets which would
entail significant public sector growth (15.56% as of November 2013 against the June 2014 target of
22.90%).
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Table: External Sector
Foreign exchange reserves grew by 18.01% in the first six months of FY14. A slower pace of growth
would be likely in the second half of FY14 due to expectations of slower export growth (possible
slow-down in RMG sector orders), higher import growth (increase in investor confidence) and
lower remittance inflow growth (due to a 36 percent drop in number of migrants in FY13).
Exports, imports and remittance were expected to grow at 8%, 9% and -4% respectively in FY14. The
Capital Account Balance saw a surplus of USD 1.4 billion during July-November 2013 (219.6% YoY
growth) which could be explained by robust export growth of 18% during the period which also
compensated for the decline in remittances. The capital account saw a slight increase in foreign direct
investment in the first five months of FY14 which could possibly be explained by reinvestment from
existing firms (e.g. 3G upgrading by telcos). However, there have been fewer new foreign firms
entering the market due to political instability. Domestic output growth (mainly the
service and manufacturing sector) was slow in FY14 due in most part to the frequent national shut-
downs. BB forecasted the output growth to pickup in the second half of FY14 and partly makes up for
the losses in the first half. FY14 real GDP growth was projected to be 5.8-6.1%.
Figure 5.5: Regional inflation
Fast forwarding to December 2014 sees a pattern of declining inflation (6.2% inflation in
November, down from 6.6% in October which is a 25 month low) following the trends of India, Sri
Lanka and Pakistan6 Correlated inflation between the four countries was caused by declining
commodity prices in the world. This decline has been driven by falling food prices where as
non- food inflation has been rising gradually.
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Figure 5.6: Food vs. Non-food Inflation
The government's plan to increase gas and electricity prices in addition to implementing a public
sector wage hike (first since June 2009) would normally be inflationary in nature. However, weak
global commodities prices can help keep inflation in check. In addition, Bangladesh Petroleum
Corporation (BPC) is likely to lower oil prices, following the examples of India, Pakistan and
Sri Lanka.
It was expected that Bangladesh Bank would reduce the repo rate from 7.25% to 7%. According to
BRAC EPL, this appeared to be justified since inflation was below the target of 6.25% without
the benefit of a fuel price cut. The rate cut was expected to provide further stimulus at a time
when the economy was showing initial signs of picking up after almost two years of stagnancy.
Overall, banks stood to profit due to lower interest rates which would have likely seen an increase in
real returns on equities and bonds. However since January 2015, the incessant political situation has
cast a dampener on these expectations.
At last, it can be come to the point that though many expectations are meant to be met at the inception
of the monetary policy in every fiscal year, but due to many systematic risks, the problems become
unavoidable sometimes causing less implementation of the monetary policy. In the next chapter, on
the basis of these analyses, the trend of monetary policy in 2015 is going to be discussed.
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Chapter 6
Challenges of Establishing Monetary Policy in
Bangladesh
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Challenges of Establishing Monetary Policy in Bangladesh:
Formulation of monetary policy is not easy task. Monetary policy is formulated by central bank of a
particular country. Central bank should be very much careful while formulating monetary policy.
Monetary policy is formulated by Bangladesh Bank in Bangladesh. Bangladesh bank faces some
challenges when it has formulated monetary policy. The challenges of monetary policy in Bangladesh
are as follows:
Figure 6.1: Challenges of Monetary Policy
1. There Exists A Non-Monetized Sector: There is a large non-monetized sector, which
hinders the success of monetary policy in Bangladesh. People mostly live in rural areas where
barter is practiced. Consequently, monetary policy fails to influence this large segment of the
economy.
2. Excess Non-Banking Financial Institution (NBFI): Non-bank financial intermediaries like
the indigenous bankers operate on a large scale in Bangladesh. But they are not under the
Challenges of
Monetary Policy
Non-Monetized
Sector Non-Bankig
Financial Institution
Unorganized Financial Market
Higher Liquidity
Black Money
Lack of Honesty
Existence of Inflation
Shortage of Real Factors
Lack of Integrated
Interest Rate Structure
Time Lag
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control of the monetary authority. The factor limits the effectiveness of monetary policy in
such countries.
3. Existence of Unorganized Financial Market: The financial markets help in implementing
the monetary policy. In Bangladesh, the financial markets specially the money markets are of
an unorganized nature and backward conditions, in many places people like moneylenders,
traders and business actively take part in money lending, but unfortunately they do not under
the purview of monetary policy and creates impediment in the success of a monetary policy.
4. Higher Liquidity Hinders Monetary Policy: The majority of commercial banks of
Bangladesh possess high liquidity so that they are not influenced by the credit policy of the
Bangladesh bank. This also makes monetary policy less effective.
5. Black Money: In Bangladesh, large quantity of black money exists due to political and
economic factors. Black money is used for activities such as hoarding and speculative
motives etc. As a result, it hinders the true spirit of the various objectives of monetary policy.
6. Lack of Honesty: In Bangladesh, administrative honesty and firmness are not very rigorous.
This leads to problem of tax evasion, anti-social elements, black money etc. These parallel
economies help speculations and illegal trading and thereby reduce the efficiency of the
monetary policy.
7. Existence of Inflation: The economy of Bangladesh is highly sensitive to inflationary
pressures. Government incurs huge expenditures on various types of development projects. It
increases the effective demand much more than output of consumer goods. The result is a
sharp rise in the internal price level. Moreover, during the course of hyperinflation, tools of
monetary policy fail to work properly.
8. Shortage of Real Factors: Another problem in Bangladesh exists that there is a shortage of
real factors like capital, entrepreneurial ability etc. therefore; monetary policy can do nothing
about it.
9. Lack of Integrated Interest Rate Structure: In Bangladesh, the various types of interest
rate exist. The various types of interest rates prevalent in the money market do not bear any
definite relationship with the bank rate of Bangladesh. Any changes affected in the bank rate
do not produce proportional changes in the other interest rates. The result is that the
Bangladesh Bank is unable to control the money market in an effective manner and monetary
policy fails in its operation.
10. Time Lag: The success of monetary policy depends on timely implementation of it,
however, in many cases unnecessary delay is found implementation of the monetary policy,
or many times timely directives are not issued by the Bangladesh Bank, then the impact of the
monetary policy is wiped out.
Because of these limitations of monetary policy in Bangladesh, economists formulate fiscal policy
along-with it.
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Chapter 7
Overview of Monetary policy Statement (July-
December 2015)
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Monetary policy of Bangladesh is regulated by Bangladesh Bank. For each fiscal year Bangladesh
Bank announce its monetary policy. The recent monetary policy statement of Bangladesh Bank for
July-December 2012 is described below on the perspective of star model of monetary policy.
Figure 7.1: Star model of monetary policy.
Global Developments
Signals received from the global outlook are mixed. While Europe is floundering in near recession,
US recovery is evident if not robust. Europe has already been engaged in massive quantitative easing
and considering more to come, but the United States signals raising the Federal funds rate at least
slightly to combat the rising signs of inflation since their economy is reinvigorating.
The story of Chinese double-digit growth has gone out of steam and it will remain so for a while. Its
projected growth for 2016 turns out to be 6.3 percent. In contrast, India, which fell behind China in
the growth race over the last liberalization period of 3 decades, has exceeded its regional rival by
projecting a growth figure of 7.5 percent for 2016.The global growth of 3.8 percent includes 2.4
percent growth in advanced countries and 4.7 percent growth in emerging and developing nations.
The developing bloc will face 4.8 percent inflation in 2016 while the number is only 1.4 percent for
the advanced bloc.
Exchange Rate
Growth
Inflation
Interest Rate Money Supply
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Table: Overview of World Economic Outlook
Source: IMF World Economic Outlook, April 2015
Based on these projections, the government's 7.0 percent growth target seems ambitious but attainable
subject to providing the right enabling environment. The 6.2 percent CPI inflation target announced in
government's FY16 budget, not far off the current levels, has been used alongside the 7.0 percent
GDP growth target in chalking up Bangladesh Bank's FY16 monetary program.
Economic Growth
When China with its' double digit growth for 24 years has now come down to the 6 plus range, India's
7.5 percent growth projection remains encouraging for Bangladesh being India's neighbor and a
dominant trade partner. Needed enabling environment for attaining 7 percent real GDP growth in the
FY16 would include urgent redressing of infrastructural and administrative deficiencies impeding
investments, alongside preserving political calm and stability.
Inflation
An economy cannot thrive without macro stability which requires moderate inflation and price
stability. Hence, moderate inflation lies in the core objective of the central bank. The word 'moderate'
is susceptible to various interpretations. But, we try to be more definitive. For a developing economy
like Bangladesh, various empirical studies and the public perception define a range of 4 to 6 percent
inflation as moderate. The upper limit of this range may move further up if the economy is
accelerating at 7 percent or above. Then affording an inflation rate of 7 or 8 percent will be necessary
to absorb the speeding up of employment, output, and wages.
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Figure 7.2: General & core inflation.
Given the background, Bangladesh's current level of inflation at 6.4 percent is already moderate. The
government's 6.2 percent target for the FY16 implies that we need to go for further reduction by
slightly pressing the brake on the price level. Now if money supply remains on the current stance that
is cautious in general but at the same time generously accommodative for growth generating pursuits,
achieving that target will not be difficult.
Although general inflation has fallen from 6.87 percent in January 2015 to 6.40 percent in June, core
inflation that counts nonfood and nonfuel inflation is on the rise. It has inched up from 6.08 percent in
January 2015 to 6.74 percent in June of the same year, warranting a cautious stance right now. That is
reflected in the money supply and repo rates of the central bank.
Money Supply
Based on the conflicting signals from general inflation and core inflation, Bangladesh Bank decides to
remain on their current cautious but generously supportive stance for inclusive, sustainable output
growth.
Table: Monetary Aggregate (Y-0-Y growth in %)
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Following the growth supportive stance, the Bangladesh Bank plans to increase broad money (M2) at
rate of 15.6 percent. This stance of money supply complies with the growth target, absorbs moderate
inflation, and finally takes required level of monetization into account.
Policy Interest Rates
The repo and reverse repo rates have been kept unchanged at 7.25 percent and the 5.25 percent
respectively, for several months now. However, gains in inflation decline earned over this period do
not yet make a case for easing of policy interest rates, given that both headline point-to- point CPI
inflation and core CPI inflation have edged up recently. The fall in general inflation mainly came
from the declining food prices. Food inflation fell from 7.68 percent in January 2015 to 6.68 percent
in June of the same year. Here runs the public perception that the fuel price reduction mainly affected
general inflation. But, the government did not adjust that reduction to domestic prices. Although
expectations owing to the global fuel price might have played a positive role in dampening
inflationary concerns, the food component that occupies almost 60 percent of the consumption basket
played the major role in pulling the general inflation figure downward
Figure 7.3: Contribution to twelve month moving average inflation
Based on just food prices, which are more volatile in nature, it will not be prudent to expect that
general inflation and in particular nonfood nonfuel core inflation will be falling when nonfood
inflation is rising. Hence, Bangladesh Bank remains cautious on inflation and is refraining from
policy rate easing right away, but will not hesitate to do so as point-to-point and core CPI inflation
take sustained downward turn.
In addition, the fall in interest rates is not significant enough to warrant a downshift of policy rates
immediately. For example, the weighted average deposit rate fell from 7.71 percent in July 2014 to
6.99 percent in May 2015. The average spread, which stands on the average deposit rate to give us the
average lending rate, fell from 5.13 percent in July 2014 to 4.83 percent in May 2015. Consequently
the average lending rate fell from 12.84 percent in July 2014 to 11.82 percent in May 2015.
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Figure 7.5: Interest rate spread
The call money rate has fallen from 8.57 percent in January to 5.79 percent in June 2015. The changes
are nevertheless not substantial enough to outweigh the concern about rising core inflation. Policy
rates will, therefore, remain on the course as before. As already indicated, we will revise them
whenever further developments warrant us to do so.
Selective Easing
In the FY16 Bangladesh Bank will continue with the existing stance that is cautious overall but
clearly accommodative in supporting productive pursuits. Commercial banks have been motivated
and supported in extending loans to the productive and vulnerable sectors at lower interest rates.
Green projects will avail loan at a lower rate and so will export promotion activities. The World Bank
has committed to contribute USD 300 million as credit. The World Bank money will be for medium
to longer term foreign currency financing of manufacturing projects. Bangladesh Bank will add
another USD 200 million which will be specifically for greening initiatives in the export oriented
textiles, apparels, and leather sectors.
In summary, a fund for USD 500 million will be created to support medium and long term projects,
specially, environmentally responsible investments at lower interest rates. Bangladesh Bank extends
low cost funds to promote women entrepreneurships, skill building projects, and energy expansion
initiatives.
Bangladesh Bank has so far disbursed taka 140,000 million under refinance schemes to support above
subsectors. It may be noted that the Export Development Fund (EDF) has been increased to USD 2
billion from only USD 100 million in 2006. Peasants get low cost credit and so do sharecroppers.
Thus, Bangladesh Bank has adopted selective easing through judicious variations of interest rates. If
taken together, the productive sectors are accessing low cost financing and hence contributing
substantially to the supply side capacity of the economy.
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Exchange Rate and Foreign Reserves
Bangladesh Bank has kept on buying foreign exchange to protect external competitiveness of taka by
easing appreciation pressures on it. The central bank, however, exercises a managed float to maintain
exchange rate stability by ironing out day-to-day fluctuations. Preserving that stability is an integral
part of monetary policy although infrequent adjustments to market pressures have been carried out in
the past. That policy stance helped Bangladesh Bank to maintain exchange rate stability for the last 2
years and a quarter since early 2013.
Figure 7.6: Exchange rate of USD/ Taka
While the central bank's purchases of foreign currencies from the market is defusing appreciating
pressures on taka and thus on the exchange rate, lackluster performances of exports convince us to
lower the value of taka against the dollar and thus depreciate the exchange rate. Since taka is pegged
with the dollar that has much appreciated against other major currencies like Euro, the real effective
exchange rate (REER) is also on the rise. Whether this development appears to be the main reason for
the weak export performance over the last fiscal year is a matter which remains to be substantiated.
Our exporters have been prudent enough to go for natural hedging by going mostly for US dollar
based export contracts even with the European buyers.
Bangladesh's FY15 export growth slowdown to 3.35 percent is attributable largely to demand
weakness in the European Union from the Greek debt debacle and other malaise. In the last FY15,
imports grew at around 12 percent - a rate much higher than export growth of 3.4 percent. If that trend
continues, appreciating pressures will gradually die out, sending Bangladesh Bank to a position that
enables depreciation with better ease.
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Figure 7.7: Forex reserve and import cover.
Bangladesh Bank's foreign exchange reserves have grown fast to a level generally deemed as
adequate, but not yet to a level that could be viewed as excessive, seen against those of other
developing economy comparators. At the moment, this amount can meet approximately 6 months’
import bills. Bangladesh Bank also sees a slowdown in the growth rate of foreign exchange reserves
in the near future because of imports1 outpacing exports by around 8.5 percentage points.
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Advocacy on Monetary Policy: Perspective of
Bangladesh
a) In Bangladesh, capital markets should be expanded and organized enough to succeed
the monetary policy.
b) The credit control mechanisms like open market operation, bank rate, etc. should be
effective.
c) A narrow bill market should make the discount rate effective.
d) Banking habits are also underdeveloped which hampers the effectiveness of monetary
policy seriously. So banking habits should be developed.
e) Steps should be taken to abolish the existence of liquidity trap.
f) To run the monetary policy smoothly and effectively, it is essential to pay sufficient
attentions to increase the GDP.
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Conclusion: In view of formulating credible monetary policy to attain the achievement of economic
objective, the difficult part for the central banks is to distinguish, within ongoing inflation
evolutions, between short term volatility and the underlying pressure of inflation,. While it
has now become standard practice for most central banks around the world to monitor core
inflation, no progress has so far been made in the Bangladesh context. The paper takes a
pioneering look in measuring core inflation in Bangladesh focusing on the popular exclusion
and trimmed mean approaches. The performance criteria adopted in this analysis so that the
measure of core inflation developed in the paper has strong money induce characteristics and
therefore, can credibly be used as a short or medium term guide of monetary policy in
Bangladesh.
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