Bangladesh’s Struggle with Effective Inflationary ControlThis high inflation is causing serious problems for the economy. It’s making it hard for local businesses, scaring away investors, and making the gap between rich and poor even wider.
Unlike richer countries that are doing a good job controlling inflation, Bangladesh is struggling. Its inflation rates are way higher than in nearby countries like India and Sri Lanka, where prices are going up much slower.
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In the financial world, interest rates are like conductors, guiding how much it costs to borrow money and directing the economy’s movements. Most countries use interest rates to keep inflation under control, but Bangladesh isn’t having much luck. While places like the US and UK are seeing success in managing inflation, Bangladesh’s efforts haven’t been as effective, and prices keep rising.
High Inflation, Sluggish Growth for Bangladesh
In October 2023, the Bangladesh Bank raised its policy rate to the highest level seen in decades, marking a significant move in financial policy. Preceding this, July ushered in a new score, a reference rate composed of a symphony of financial instruments, resulting in a surge of average lending rates to 13.55% by March.
As lending rates ascended, credit growth faltered, and the gears of production ground to a halt. Yet, amidst this economic allegro, consumers found no respite. Inflation stubbornly lingered at a fortissimo of 10%, unchanged since the overture of June.
Bangladesh Bank’s Monetary Policies Timeline
- October 2023: Bangladesh Bank raises policy rate to highest level in decades
- July 2023: Introduction of new score, reference rate for financial instruments
- March 2024: Average lending rates surge to 13.55%
In a recent IMF symposium, Bangladesh’s monetary composition faced scrutiny. The verdict: the central bank’s efforts failed to tame inflation as expected. Gloomy forecasts echoed globally too. The World Bank predicted high inflation and sluggish 5.7% growth. Business leaders echoed concerns, citing rising costs and shrinking profits. Amidst high inflation, production dwindled, worsening supply shortages and price pressures.
The recent financial turmoil in Bangladesh can be traced back to decisions made by the central bank. Measures aimed at shoring up reserves and curbing inflation, such as import restrictions and taka depreciation, have backfired, fueling economic instability. Despite efforts to bolster reserves through taka depreciation and import restrictions, they remain insufficient to unlock the next IMF $4.7 billion loan tranche.
These actions have a ripple effect across the economy, driving up costs of raw materials and essentials. With the scarcity of dollars and discrepancies between official and curb market rates, obtaining dollars becomes costlier and harder, exacerbating price hikes for consumers. Despite acknowledging the depreciating taka’s role in inflation, Bangladesh Bank‘s repeated policy rate hikes haven’t curbed it. In contrast, the US and UK have seen inflation decline after their own rate hikes.
In Bangladesh’s economic opera, the link between policy rates and inflation remains elusive, as evidenced by the recent escalation of the policy rate to 8% in January, with inflation stubbornly defying expectations four months later.
Factors Fueling Inflation:
- Covid-19 pandemic disruptions
- Ukraine-Russian conflict
- Currency depreciation
- Energy price shocks
Additional Key Factors:
- Fixed interest rates
- Unchanged exchange rates
- Excessive monetary stimulus
A Cautionary Tale in Inflation Management
In its latest policy announcement for January-June 2024, the central bank revealed plans for a gradual shift to a market-based exchange rate system, aiming to stabilize exchange rate volatility and conserve foreign exchange reserves. This entails implementing a crawling peg system, a strategy endorsed by economists. However, despite the announcement, exchange rate volatility persists as the implementation of the crawling peg system remains pending, subject to careful scrutiny by central bankers.
Despite the taka’s depreciation, export growth remains sluggish at 4-5%, showing that even a 30% currency devaluation can’t offset labor and capital productivity challenges or high business costs. Amidst this economic turmoil, the central bank projects inflation to align with the government’s target by June FY24. However, the IMF predicts inflation will stubbornly hover above 9.3% this fiscal year before slightly easing in FY25.
As inflation persisted longer than expected, advanced economies feared stagflation, where inflation and unemployment rise together. To combat this, central banks across the world raised interest rates and pursued contractionary monetary policies, prioritizing inflation control over unemployment concerns.
Case Study of Advanced Economies
United States:
Inflation reached 9.1% in June 2022, highest in four decades
Action: Raised interest rates significantly, leading to a drop in inflation to 3.1% by January 2024
India and Europe:
Curbed double-digit inflation without harming economic growth or employment
Turkey:
Lowered interest rates despite facing 20% inflation
Outcome: Inflation soars to 80% in 2022 due to risky political influence
Resolution: Turkey raises rates to 40% to stabilize the situation
In the United States, inflation surged to 9.1% in June 2022, the highest in four decades. Responding swiftly, the Federal Reserve hiked interest rates to levels not seen in 23 years. This decisive action led to a significant drop in inflation, which fell to 3.1% by January 2024. Similar results were seen in India and Europe, where monetary policies curbed double-digit inflation without harming economic growth or employment.
However, not every country acted wisely during inflation. Turkey, for example, lowered interest rates despite facing 20% inflation. This risky move, influenced by politics, led to a disastrous outcome—inflation soared to 80% in 2022. Eventually, Turkey raised rates to 40%, slowly stabilizing the situation.
Identifying the Culprits and Central Bank Response
Bangladesh is grappling with intense inflation, fueled by disruptions from the COVID-19 pandemic and the Ukraine-Russian conflict, along with currency depreciation and energy price shocks. However, this explanation overlooks other key factors like fixed interest rates, unchanged exchange rates, and excessive monetary stimulus. The initial belief that inflation was temporary hindered action, as did the reluctance to adjust interest rates. These missteps worsened the currency’s decline and strained foreign reserves.
The urgent need for a more aggressive interest rate policy is underscored by the significant impact of the taka’s depreciation, accounting for up to 40% of inflationary pressures. This strategy can mitigate inflation and restore financial stability by making taka assets more attractive.
Looking ahead, there is hope as the Bangladesh Bank shifts towards a tighter monetary stance, abandoning the old policy band and opting out of central bank borrowing for budget financing. This move has already led to higher interest rates on treasury bills and bonds, signaling a shift towards more proactive measures.
Positive signs of economic stability are emerging, with the external current account in surplus and foreign exchange reserves stabilizing at $18-20 billion. The current account is in surplus, reserves are stable, and the exchange rate has steadied. Moody’s has upgraded the banking sector outlook due to increased profitability and improved liquidity from abandoning fixed interest rates.
| Positive Signs of Economic Stability: | Recommendations for Further Action: |
| External current account in surplus | Incremental 50 basis point policy rate hikes monthly for four months |
| Foreign exchange reserves stabilizing at $18-20 billion | Unifying exchange rate |
| Exchange rate steadied | Cutting non-essential spending |
| Moody’s upgraded banking sector outlook | Avoiding central bank financing for deficits |
| Vigilance against surge in budgetary spending in FY2024’s final quarter |
Yet, more must be done. The Bangladesh Bank’s 25 basis point policy rate hike is a start, but a bolder approach is needed. Incremental 50 basis point hikes monthly for four months can help normalize rates and tackle inflation.
Beyond rate adjustments, unifying the exchange rate, cutting non-essential spending, and avoiding central bank financing for deficits are crucial steps. Vigilance is key as budgetary spending may surge in FY2024’s final quarter.
Though there were delays, current policy measures are moving in the right direction. Strengthening orthodox policies and giving them six to nine months to work is crucial for achieving desired outcomes.
