How fixed rate regime makes Bangladesh Bank’s monetary tools ineffective

Ineffectiveness of monetary tools

• BB sets LC rate at Tk87.90 per dollar; market rate Tk95-97
• BB sets deposit rate above inflation; banks set 4% deposit rate, while inflation is 6%
• Official remittance rate Tk87.90 per dollar; kerb market rate Tk97-100
• Inflation target 5.4%; April rate 6.29%
• Policy rate 4%; call money rate 4.76-8.60%

At a time when the country's money market has been experiencing high volatility amid rising inflation and shortage of foreign currency, the Bangladesh Bank's monetary tools seem dysfunctional in bringing order to the market due to the fixed rate regime.

Though inflation is on the rise, the central bank has not been able to use its policy rate to tighten the money flow due to the fixed lending rate. The policy rate has been increased to make money costlier by raising interest rates on loans, but when the lending rate is fixed, the policy rate becomes useless.

The fixed exchange rate has also become almost redundant in the foreign currency market as banks are mostly ignoring the official LC (letter of credit) rate set by the central bank.

Though the Bangladesh Bank has continued to devalue the local currency, setting the latest LC rate at Tk87.90 per dollar, it has not been effective in case of settling import bills as banks are charging above Tk95 against the greenback.

The Bangladesh Bank's decision to sell a large amount of dollars in the market to meet the shortage in banks has further caused an erosion of the forex reserve and created pressure in the local currency market as well.

The central bank has sold $5.5 billion dollars since August last year until 19 May through which the authority mopped up around Tk50,000 crore from the market.

After the Bangladesh Bank injected dollars to meet the shortage, a widening trade deficit remains a major concern for the country.

The country's trade deficit is growing sharply owing to a massive increase in imports compared to exports and the rise in prices of all kinds of products, such as food items and fuels in the world market.

In the first nine months of the fiscal 2021-22, the trade deficit was about $25 billion, 9.25% higher than that of the full period of the previous fiscal year.

The official exchange rate fixed by the central bank also discourages remitters from bringing in foreign currency through banking channels as the difference between the official and kerb market rate is higher than Tk10.

The high difference between the two rates has resulted in the government's 2% incentive for remitters not working out as expected.

Remittance growth declined by 16.25% in the July-April period of the current fiscal year compared to the previous year, according to central bank data.

Amid this situation, the Bangladesh Bank recently eased the documentation process for availing of the 2% incentive in sending remittances above Tk5 lakh.

Professor Dr Mustafizur Rahman, distinguished fellow at the Centre for Policy Dialogue, said the dollar market has become more speculative and unpredictable.

Though there was devaluation pressure, the Bangladesh Bank moved slower than other competitor countries such as India, China and Pakistan, he said.

As a result, a demand pressure developed in the market, causing a major regulatory failure on the part of the Bangladesh Bank in implementing its fixed exchange rate, he said.

Now, however, the central bank is devaluing the taka faster and taking many steps to slow down imports, he commented.

On the other hand, dollar selling created pressure on the local currency market, causing a sharp fall in excess liquidity in the banking system.

The total excess liquidity declined by Tk31,000 crore in seven months from its highest level of Tk2.31 lakh crore in August last year to Tk1.99 lakh crore in May this year, according to the Bangladesh Bank data.

While banks are still in the comfort zone in terms of liquidity, they have become more conservative in lending due to fears of a liquidity crunch in the future.

Cautious lending by banks is already reflected in stimulus loan disbursement and private sector credit growth.

In the second round during the current financial year, the target for stimulus loans for the Cottage, Micro, Small and Medium Enterprise (CMSME) industries was set at Tk20,000 crore. However, loans disbursed during the July-March period of this fiscal year were only 45.71%, or Tk9,120 crore, of the total amount. But 76.93% of the first round of stimulus loans were disbursed in the same period.

Furthermore, private sector credit registered 11.29% in March, mostly contributed by import financing, which was still far below the monetary target of 14.8% set for June by the Bangladesh Bank.

The central bank could not even safeguard the depositors as banks are mostly ignoring instructions on keeping the deposit rate above inflation.

In August last year, the Bangladesh Bank set a floor on deposit rates for the sake of depositors as they were getting an interest return lower than the inflation rate, which erodes their purchasing capacity.

Banks were asked to set the deposit rate above inflation in case of individual depositors.

However, banks are mostly ignoring this instruction too as the weighted average deposit rate in the banking industry remained almost the same at 4% since the issuance of the instruction, when inflation increased to 6.29% in April from 5.54% in August last year.

Low returns from deposits are discouraging savers from parking money in banks, causing a sharp decline in the deposit growth.

The deposit growth slowed down to 9% in March. It was above 12% during the previous year.

Selim RF Hussain, managing director of Brac Bank Limited and chairman of the Association of Bankers Bangladesh (ABB) said inflation is rising due to a commodity price hike in the global market.

However, inflation may not have a serious impact on depositors immediately, he said.

He said although banks are still lending at a 7-8% rate, if inflation remains on an upward trajectory in the coming days, policy makers will have to rethink the fixed lending rate.