Lift the interest rate cap, let monetary policy work
Skillful macroeconomic management over the past three decades has served Bangladesh well. Total export revenue, buoyed by a torrid pace of growth in ready-to-wear apparel revenue and foreign remittances, soared to $81.4 billion in fiscal 2022 from just $5.2 billion in fiscal 1990. Imports boomed, supporting rapid growth in GDP, investment, and exports. All this was possible without any pressure on the balance of payments (BoP).
The current account was either in surplus or slightly in deficit, allowing external debt to increase only moderately while reserves grew rapidly from $1.1 billion (3 months of imports) to a peak of $48 billion in August 2021 (8 months of imports for FY2021).
This comfortable BoP situation has been under pressure since September 2021, which has increased since March 2022 following the war in Ukraine and the associated increase in global inflation. Despite record foreign exchange earnings, the value of imports surged due to global inflation, resulting in a record current account deficit in fiscal year 2022 ($18.7 billion).
Reserves fell rapidly and short-term debt piled up. Reserves continued to fall in the first three months of FY2023, despite import controls. By the end of September 2022, reserves had fallen to $36.5 billion (4.7 months of forecast imports for fiscal year 2023), a staggering loss of $11.5 billion over a 13-month period. Despite import controls threatening to hurt manufacturing growth and exports, there is no sign that BoP pressure is easing.
With short-term debt reaching $20.7 billion in June 2022 and continued pressure from the BoP, it is not comforting to see reserves shrinking at such a rapid pace. With the war in Ukraine and global inflation spiraling out of the control of Bangladeshi policymakers, Bangladesh cannot afford to see the BoP situation spiral out of control. There is no sign that war or global inflation will end anytime soon.
Moreover, Europe has already entered a phase of recession and the United States risks falling into it. A prolonged period of global stagflation could seriously harm Bangladesh’s exports, which would be a very unfortunate outcome.
Bangladesh has a good track record of emerging from stressed BoP situations, as it did in FY2012, using a judicious mix of exchange rate, monetary and fiscal policies to reduce aggregate demand, lower pressure on the exchange rate and stabilize the macroeconomy. So there is hope that this time too policy makers will rise to the occasion. Unfortunately, macroeconomic management over the past 12 months or so has failed to stem the deterioration of the situation. So far, policymaking has either been ineffective or gone in the wrong direction.
The government got off to a good start by announcing its intention to free the exchange rate and protect reserves. Unfortunately, politics remained more on paper. There was an initial correction in the overvalued Bangladeshi currency, but its course of correction was halted as the Bangladesh Bank continued to inject reserves into the foreign exchange market to prevent further depreciation of the taka.
In addition, the BB has adopted three exchange rates: one for exports, one for remittances and one for imports. These multiple currency practices undermine BB’s earlier announcement that it will implement market-based foreign exchange management. The heavy loss of reserves is the price paid by the BB to protect the overvalued exchange rate. This needs to stop to put the macroeconomics back on a sustainable path.
Moreover, the adoption of the 6/9 interest rate policy has severely handicapped the government’s ability to reduce demand pressure on the BoP and domestic inflation. The absurdity of this policy is indicated by the fact that domestic inflation is now above 9%, while the maximum lending rate has been capped at 9%, indicating that the real lending rate has turned negative.
It is obvious that at negative real borrowing rates, there will be excess demand for credit. Indeed, private sector credit growth has surged in recent months, approaching an annualized growth rate of 14% in September 2022, from 8.4% in fiscal 2021. Thus, instead of reducing growth credit to reduce demand, inflationary pressures were amplified by credit acceleration, adding to BoP pressure.
The political corrections required are obvious. The exchange rate must be truly liberalized with a uniform rate and without any new injection of reserves which are already at a low level.
In order to moderate the depreciation of the exchange rate, the BB can intervene by tightening domestic credit by abandoning the 6/9 policy. It can monitor the evolution of the required correction by using its normal monetary policy instruments such as the discount rate and open market operations. The opening of treasury bills to the general public is a positive step that will strengthen monetary policy. The BB must now phase out the 6/9 policy and let monetary policy work.
The author is vice president of the Policy Research Institute of Bangladesh.