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MONETARY POLICY OF BANGLADESH
Patuakhali Science and Technology University Dumki, Patuakhali
Lecturer Department of Agricultural Economics and Rural Sociology Faculty of Business Administration and Management
05 (liberty) Level: 03; Semester: 01 Faculty of Business Administration and Management
01 Md. Mofizer Rahaman 02 Dipayan Chakma 03 K.M. Assaduzzaman 04 Tanjia Sultana 05 Azmery Khanam 06 Shofiq Uddin Khan
Member Member Member Member Member Member
12 17 06 10 20 23
00671 00676 00665 00669 00679 00682
Money and Banking Course code: FBK-312
Date of Submission: 20 April, 2008 Patuakhali Science and Technology University Dumki, Patuakhali
MONETARY POLICY OF BANGLADESH
Table of contents-
MONETARY POLICY AN OVERVIEW
THE USES OF MONETARY POLICY HOW MONETARY POLICY WORKS OBJECTIVES OF MONETARY POLICY
IN DEVELOPING COUNTRIES
03-03 03-03 03-04 04-05
INSTRUMENT OF MONETARY POLICY MONETARY POLICY OF BANGLADESH Monetary policy of Bangladesh in a view INSTRUMENTS EMPLOYED Interest rate Revision of the statutory ratios for scheduled banks DEVELOPMENT OF MONETARY POLICY IN BANGLADESH 09-10 WHAT IS INFLATION?
07-07 08-09 08-08 08-09 1011-12 11-11 11-12 12-12 12-
CAUSES OF INFLATION IN BANGLADESH
Causes relating to excess demand Factors responsible for reduction in supply Miscellaneous causes
TYPES OF INFLATION
CONTROL OF INFLATION/ ANTI INFLATIONARY
MONETARY POLICY IMPLEMENTATION IN BANGLADESH THE POLICY TARGET
MONETARY POLICY PROCESS BY BANGLADESH BANK MONETARY POLICY STANCE, JULY-DECEMBER 2007
A BRIEF REVIEW
RECENT GLOBAL DEVELOPMENTS
RECENT MACROECONOMIC DEVELOPMENTS RECENT INFLATIONARY TRENDS
Table of contents (continued)19-19
RECENT EXTERNAL SECTOR DEVELOPMENTS RECENT MONETARY DEVELOPMENTS
21-21 MONETARY POLICY STANCE FOR 23-25
SECOND HALF-FINANCIAL YEAY 2008
A BRIEF REVIEW
CONCLUSION, BIBLIOGRAPHY, REFERENCE CONCLUSION
MONETARY POLICY AN OVERVIEW
Today, the Reserve Bank uses monetary policy to control inflation and keep it within a specific target band. Monetary policy is encountered in several ways. Bangladesh directly encountered the main instrument of monetary policy, the Official Cash Rate (OCR), when they borrow money at retail interest rates through mortgages, credit cards or personal loans, or when they save money in bank accounts that earn interest. Retail rates of interest are directly related to the OCR set by the Reserve Bank. Monetary policy helps prevent large swings in economic growth and employment. Monetary policy is the management of monetary supply and interest rates by central bank to influence prices and employment.
Monetary policy works through expansion and contraction of investment and consumption expenditure.
The policy by which the management of monetary system and control of money and credit are done is called monetary policy. Different economist define it as follows— • Paul Einzing: Moetary policy includes all monetary decisions and measures irrespective of whether their aims are monetary and non monetary and all non monetary decisions and measures that aim it affecting the monetary system. • Harry G. Johnson: Monetary policy employing the central bank’s control of supply of money as an instrument for achieving the objectives of general economic policy. • C. K. Johri: A monetary policy will consist of the decisions of the Government and the central bank, which affect the volume, and consumption of money supply, the size distribution of credit the level and structure of interest rates and the effect of these variables on the factors determining price and output. Under these circumstances, monetary policy refers the central bank’s policy to control of the availability, cost and use of money and credit with the help of monetary measures in order to achieve the specific goals.
THE USES OF MONETARY POLICY
• Monetary policy can’t change the long-term trend growth. • There is long-term trade off between growth and inflation. • When monetary pressure build up— Raise the short -term interest rates which raise real rates across the economy, which squeezes consumption, and economy.
HOW MONETARY POLICY WORKS
• over the business cycle • Monetary policy and employment • Monetary policy and current account • Monetary policy and growth
OBJECTIVES OF MONETARY POLICY IN DEVELOPING COUNTRIES:
There are some monetary policies in developing countries they are— i. Price stability
Inflation distorts economic calculation and expectations while deflation creates depression in the economy. So both inflation and deflation are harmful for the economy. Thus, price stability should be main aim of monetary policy. Prices stability promotes business confidence, makes economic calculations possible, control business cycle and introduces certainty in the economic life. ii. Exchange stability
Maintenance of stable exchange rates is an essential condition for the creation of international confidence and promotion of smooth international trade on the largest scale possible.
In under develop countries like Bangladesh the full employment objective is more crucial, because such economies have both un-employment and underemployment open and disguised. In less develop countries though full employment can not be achieved with in a short period, the monetary policy should try to achieve at least a near full employment situation.
This is comparatively a recent objective of monetary policy. It refers to the growth of real income or out put per capita. Monetary policy can contribute to economic growth in a efficient way. v. Neutrality of money
Neutrality of money indicates a situation in which changes in the quantity of money in such a way as to cause a proportionate change in the equilibrium prices of commodities and the equilibrium rate of interest remain unchanged. If money is neutral, an increase or decrease in the quantity of money will not produce any disturbing effect in the economy. vi. Balance of payment equilibrium
Balance of payment equilibrium condition is a position at which a country repaid its debt and has attained an adequate reserve at zero balance over time. This objective on monetary policy has become significance in the post war period.
INSTRUMENT OF MONETARY POLICY
Instrument of monetary policy generally mean the different means of controlling credit in the economy. The instruments are as follows— a) General or qualitative instruments: (i) (ii) (iii) Variable reserve ratio Bank rate Open market operation
(b) Qualitative or selective credit control instrument
(a) General/ quantitative instruments These instruments influence the credit creating capacity of the commercial banks by affecting directly or indirectly the excess of the banks. Different forms of quantitative instrument are:
Variable reserve ratio: Banks are legally required to maintain a certain percentage of their deposits in the form of cash. It determines the capacity of banks to make loans or purchase securities. The central bank can influence the credit creation capacity of the commercial banks by controlling the volume of cash reserve and the minimum legal reserve ratio. Bank rate: It is the rate at which central bank lends money to the commercial banks. If bank rate is increased it will increases the
cost of borrowing of commercial banks, which in turn reduces the capacity of credit creation of the commercial banks. In the opposite way, a reduction in bank rate will increase the amount of credit created by commercial banks.
Open market operation: Open market purchase of securities by the central bank will give more power and money in the hands of commercial banks to expand credit creation. The opposite will happen if there are sales of securities by the central bank.
(b) Qualitative/ selective credit control instrument It deals with the use or direction of credit. Through the qualitative instruments, the central bank can expand the use of credit in the desired and priority sectors, or can restrict the use of credit in the unwanted and unproductive sectors.
MONETARY POLICY OF BANGLADESH
MONETARY POLICY OF BANGLADESH IN A VIEW
Both in developed and developing economies, monetary policy seeks to maintain price stability accompanied by sustained stable output growth in the face of internal and external shocks that are faced from time to time. For developing economies like Bangladesh with significant underemployment/under exploitation of production factors, stimulating higher growth is imperative for rapid reduction and eventual elimination of endemic poverty, and is therefore an overriding priority. Objectives of the monetary policy of the Bangladesh Bank as outlined in the Bangladesh Bank Order, 1972 comprise of attaining and maintaining of price stability, high levels of production, employment and economic growth. In the decades of seventies and eighties, monetary policy in Bangladesh was conducted with full direct control on interest rates and exchange rates, as on the volumes and directions of credit flows. The situation began changing in the nineties with the abolition of directed lending and gradual liberalization of interest rates. From then on, interest rate and exchange rate are both market driven, exchange rate is no longer in the role of nominal anchor for prices.
Monetary policy in Bangladesh is formulated around inflation and output growth rates as the basic policy targets. Levels and growth paths of relevant monetary aggregates such as reserve money, broad money and domestic credit are also projected and monitored as intermediate targets in conducting monetary policy. CPI inflation, expressed as the rate of change of Consumer Price Index, is used in Bangladesh for measuring price stability in conducting monetary policy. The target level of CPI inflation is chosen taking into account the country's past long run inflation performance, and the domestic and external factors driving the current trend of domestic inflation. Apart from a brief spell of relatively high instability of prices in the mid seventies, inflation in Bangladesh has always been contained at moderate levels.
INSTRUMENTS EMPLOYED Interest rate
In tightening the monetary policy stance, key policy rates (treasury billlbond auction yields, repo and reverse repo interest rates of Bangladesh Bank) have been raised and maintained on uptrend, for these in turn to raise the rates of other financial costs and returns, restraining demand growth in the real sector.
Revision of the statutory ratios for scheduled banks
The markets are yet to gain sufficient depth to respond with the changes in policy interest rates. To compensate for this inadequate interest rate responsiveness of markets, policy interest rate interventions in Bangladesh are at times supplemented by changes in the Cash Reserve Requirement and Statutory Liquidity Ratio for scheduled banks. Annual monetary programs based on the inflation and GDP growth targets of monetary policy provide a convenient framework for interventions in monetary developments, and for monitoring the outcome of the monetary policy stance pursued. Based on the assumption that inflation rises and falls with increase and decrease in the rate of growth of money stock, the annual monetary program targets a growth path for broad money consistent with the inflation and real GDP growth targets of monetary policy, allowing for the likely change in income velocity of money.
Levels of another monetary aggregate, Reserve Money (currency in circulation plus balances of banks with the Bangladesh Bank, also termed 'high powered money') is regulated with open market operations (periodical auctions of treasury bills/bonds) and daily repo, reverse repo auctions; towards maintaining broad money on the growth path targeted in the monetary program. The monetary program is nevertheless very useful as framework for gauging the growth supportiveness and the inflation stabilization effectiveness of the monetary policy stance pursued. The broad money growth target of the monetary program has further been disaggregated into sub targets on the asset and liability side. On the asset side, the net foreign asset and net domestic asset growth outcome relative to the targets and to each other indicate the relative performance in the domestic and external sectors of the economy; the outcome in growth of credit to the public and the private sectors relative to program targets indicate whether the available credit volumes were short of or in excess of what was needed for the targeted GDP growth. While contractionary monetary policy continued beyond FY 05 to clean up monetary overhang, GDP growth rate for FY 06 is estimated at much higher rate of 6.5 percent mainly reflecting better performance of agriculture sector supported by growing industrial and services sectors. The growth rate would even be higher depending on final outturn of the boro crop. Our present challenge is to stabilize inflation rate. One caution the pro-poor growth drive is facing-is the rise in inflation rate-not only caused by the aftermath of the flood last year and rapid credit expansion but also due to rise in fuel and commodity prices around the globe; which is beyond our control. Inflation rate that stood at 7.35 percent in June 2005 rose to 7.95 percent in November 2005. With a brief down swing during early months of 2006, it again started moving up to 6.17 percent in March 2006. We hope the monetary stance and prospective growth along with optimistic global economic scenario would bring down the price level within a short period.
DEVELOPMENT OF MONETARY POLICY IN BANGLADESH
Monetary policy aims and methods have changed over time. Bangladesh was a part of Pakistan. Then in East Pakistan the monetary policy was circulated by the State Bank of Pakistan (the Central Bank). By the liberation war of 1971, Bangladesh was separated from Pakistan. After the outbreak of war, the government regulations played a significant part in the economy, by establishing Bangladesh Bank as a Central Bank of Bangladesh in 1972. The Central Bank was instructed to use monetary policy to reconstruct the whole economy, enhance growth, reduce unemployment, and keep prices stable. At the time, this was a largely administrative exercise. Then Bangladesh was suffered from high inflation with a war destructed poor economy. Government efforts to reduce it by regulation were not effective, but both research and practical experience overseas indicated that inflation could be reduced by controlling the money supply. Inflation control by the central bank has historical precedent. Monetary policy is a systematic and structured process. It changes on behalf of the demand of the time. The Bangladesh Bank (BB) has been announcing its monetary policy stance on a biannual basis through the Monetary Policy Statement (MPS) since January 2006. The policy stances envisage ratio, reverse ratio, and BB bill rates as the routinely employed policy instruments for influencing financial and real sector prices towards the targeted path of inflation. The annual monetary programmes adopt the reserve money and broad money as intermediate targets; supported by a framework for regular tracking of other asset and liability side sub-aggregates. The present Monetary Policy provides that Bangladesh Bank intends to follow during the second half: January to June of Financial Year 2008. The prime objective of the policy stance for Financial Year20208 is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal, and monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of Financial Year 2008.
WHAT IS INFLATION?
To understand monetary policy and the way the Bank Rate works, we need to first understand inflation. This is the term used to describe the average rise in prices through the economy, and it means that money is losing its value. The underlying cause is usually that too much money is available to purchase too few goods and services, or that demand in the economy is outpacing supply. In general, this occurs when an economy is so buoyant that there are widespread shortages of labour and materials, and people can charge higher prices for the same goods or services. Inflation can also be caused by a rise in the prices of imported commodities, such as oil. However, this sort of inflation is usually transient, and therefore less crucial than the structural inflation caused by an over-supply of money. In under develop countries like Bangladesh inflation plays an important role to develop a standard monetary policy. It is a crucial for Bangladesh bank (central bank of Bangladesh) to adjust the inflation with the monetary policy.
CAUSES OF INFLATION IN BANGLADESH
There are several causes of inflation in Bangladesh. The factors responsible for inflation are discussed below•
Causes relating to excess demand
1. Excess supply of money increases the demand for goods or services. In
Bangladesh flood, cyclone and for other natural disaster, the government of Bangladesh try to increase the money supply to recover the situation. But it creates hyper inflation. Therefore, Bangladesh bank has to pass a very difficult period to build up a well structure monetary policy.
2. Deficit financing puts additional money in the hand of people to inflate
the demand. 3. Increasing government expenditure on big development projects having long gestation periods increases money supply as well as introduces inflation. 4. Excessive credit creation by banks to finance unproductive business may lead to inflation. 5. The holders of black money indulging in conspicuous consumption may increase demand and hence accentuate inflation.
6. High growth rate of population inflates demand. 7. When government pays off the public debt, purchasing power of the people increases and so the demand. Under these circumstances, it is very much difficult for any developing countries central bank, like Bangladesh to develop a stable monetary policy.
Factors responsible for reduction in supply
1. Production is hampered by in-elasticity, bottlenecks, shortage of raw materials and so on. 2. Agriculture production may be reducing by natural calamities, low and improper investment and so on. 3. Artificial scarcity created by holders, profiteers and black marketers. 4. Inflation in one country is often exported to other countries. All these factors are easily shown in the economy of Bangladesh. Therefore, Bangladesh bank has to consider all of these factors.
1. An increase in wage level and in the prices of raw materials leads to higher cost of production, therefore, higher prices. 2. In order to get a higher profit, businessperson increases the mark-up. This when added to the cost of production, increases the price level. 3. For certain articles, when import is reduced, scarcity is felt and price goes up. 4. Higher taxation also leads to a higher price level. 5. Inefficiency, corruption, poor law and order situation and so on also contribute to the inflationary spiral. 6. Devaluation also leads to inflationary consequences. 7. War expenditure also a responsible factor for inflation.
Without the war expenditure, all of other six factors must be taken under consideration for Bangladesh bank to have a perfect monetary policy.
TYPES OF INFLATION
Inflation may be classified in different ways. These are discussed below•
On the basis of intensity
a) Creeping/mild inflation: when prices rise within a range of 10% over a decade or around 1% per annum, there occurs creeping inflation. b) Walking inflation: when prices rise by more than 10% and with a range of 30% to 40% over a decade, or 3% to 4% a year, walking inflation is the outcome. c) Running inflation: when price accelerates so rapidly that it goes beyond 100%over a decade or 10% over a year, running inflation emerges. d) Galloping/ hyperinflation: prices rise every moment and there is no limit to the height to which prices might rise, means galloping or hyper inflation occur.
On the basis of causes
a) Demand-pull inflation b) Cost-push inflation c) Excessive money supply inflation • On the basis of process a) Profit-induced inflation b) Wage-induced inflation c) Deficit-induced inflation d) Foreign-trade-induced inflation
Export boom inflation
Import-price-hike inflation Key-currency inflation • On the basis of scope a) Partial inflation b) True inflation
• On the basis of time a) War-time inflation b) Post-war inflation c) Peace-time inflation • On the basis of government reaction a) Open inflation b) Suppressed/ repressed inflation For each type of this inflation, the central bank of Bangladesh takes several anti inflationary measures. These are discussed below.
CONTROL OF INFLATION/ ANTI INFLATIONARY MEASURES
1. Increase in bank rate: Bank rate means the rate at which central bank gives credit to the commercial bank. If this rate increases the commercial bank, also increase their interest rate. Thus, credit from banks decrease and inflation can be checked. 2. Open market operation: By this system Bangladesh bank sells securities and can reduce the cash in hand of the people. The fiscal measure and the others are not the direct function of Bangladesh bank. But Bangladesh bank acts as a financial advisor of the government to adopt some fiscal measures. • Fiscal measure 1. Reduction in public expenditure 2. Increase in Taxation 3. Public Borrowing 4. Promoting savings 5. Controlling deficit financing 6. Delay in public debt repayment
1. Price control 2. Rationing • Other measures 1. Increase in production 2. Increase in import 3. Decrease in export 4. Wage control 5. Blocking liquid asset
MONETARY POLICY IMPLEMENTATION
THE POLICY TARGET
As already mentioned, monetary policies in Bangladesh have the objective of maintaining price stability by the highest sustainable output growth, and are therefore formulated around inflation and output growth rates as the basic policy targets. Levels and growth paths of relevant monetary aggregates such as reserve money, broad money and domestic credit are also projected and monitored as intermediate targets in conducting monetary policies. In 2007 there was a big natural disaster in the southern part of Bangladesh called SIDR. This disaster has affected the whole country economy. Bangladesh is a country of agriculture. Its monetary policy is very much depended with agricultural sector.
Considering all of these Bangladesh bank has to construct such kind of monetary policy which can make or create a balance between cash inflow and cash outflow. Thus Bangladesh can have a well distinguished monetary policy.
MONETARY DECEMBER 2007 A BRIEF REVIEW
The policy stance was designed around a projected real GDP growth rate of 7.0 percent and an annual average Consumers Price Index inflation within a range of 6.5 percent to 7.0 percent during financial year 2008. However, the policy stance was moderated in the wake of several unexpected domestic shocks and unfavorable international
developments. In particular, the policy stance faced several key challenges:
Strong inflationary pressure emanating from both domestic and external sources that led the consumer’s price index inflation to overshoot the targeted range of 6.5 percent to 7.0 percent for financial year 2008. Low level of investment and overall economic activity resulting from natural disasters and shaken business confidence. Lagged effects of higher than programmed monetary expansion during financial year 2007 and earlier years. Excess liquidity and relatively high spread between deposit and lending rates in the banking sector.
Emergence of current account deficit resulting from widened trade deficit despite a healthy growth in workers’ remittances; and
Disruption in normal economic activity, especially in the agriculture sector and the rural economy, due to two consecutive floods and a devastating cyclone and the urgent need to undertake relief and rehabilitation efforts.
RECENT GLOBAL DEVELOPMENTS
After achieving a strong growth of 5.4 percent in 2006, the global economy is projected to grow by 5.2 percent in 2007 and 4.8 percent in 2008. On the other hand, the developing world is likely to grow by 8.1 percent in 2007 and 7.4 percent in 2008.
RECENT MACROECONOMIC DEVELOPMENTS
In view of recent domestic and external developments, Bangladesh bank has revised the GDP growth rate to lie in the range of 6.0 percent to 6.2 percent in financial year
2008. During financial year 2007, the average consumer’s price index inflation was 7.2 percent; while Bangladesh bank projects that, the average consumer’s price index inflation is likely to be in the range of 8.0 percent and 8.2 percent in financial year 2008. Given the present comfortable foreign exchange reserve position, Bangladesh bank would make the best possible judgments regarding the extent to which the recent developments in the external sector are likely to affect economic activities during the rest of the period of financial year 2008. Bangladesh bank has introduced the required flexibility in implementation of its policies to meet the shortterm exigencies especially after the floods and the cyclone, such as ensuring the flow of adequate credit to productive sector like agriculture, low cost housing, and other priority sectors and to women entrepreneurs.
RECENT INFLATIONARY TRENDS OUTLOOK
The financial year 2007 ended with a consumer’s price index inflation rate of 7.2 percent in June 2007 that exceeded the financial year 2007 target of 7.0 percent. The strong inflationary pressure inherited from financial year 2007 along with adverse changes in prospects for domestic production (mainly due to floods and cyclone) and the persistently rising prices in the international commodity market led to a steady rise in the inflation rate since the beginning of financial year 2008. It picked up to 8.25 percent in October 2007 overshooting the July 2007 monetary policy statement projection of the average inflation rate between 6.5 percent and 7.0 percent for financial year 2008. On point-to-point (pt-p) basis, the rise in the inflation rate was higher; it went up from 9.20 percent in June 2007 to 10.12 percent in August 2007 and slightly moderated to 10.06 percent in October 2007. The rise in the inflation rate in first half financial year 2008 can be attributed more to supply constraints caused by both external and internal shocks, while the demand factors remained mostly subdued as evidenced from the existence
of huge excess liquidity in the banking system. This has been mainly due to deceleration in economic activities following natural calamities, reform measures, and administrative drives against corruption and tax evasion. Moreover, Bangladesh being an import-dependent country, the economy remains highly susceptive to price changes in international commodity markets especially that of food items.
Chart 3: Inflation rate
In the international market, the prices of fuel items increased at rates between 24 percent and 45 percent and that of food items rose by between 5 percent and 67 percent over the year ending in September 2007. The international commodity price index, which includes both fuel and non-fuel price indexes, increased by around 61 percent in September 2007 over the preceding one year, largely dominated by resurgence of oil and food prices. Among the food items, prices of edible oil and wheat increased the most, both by an unprecedented 68 percent during the period. Since the
weight of food items in total consumers price index and imports is relatively high in Bangladesh, increase in food prices in the international market puts a significant pressure on the cost of living in direct and indirect ways. In recent months, the inflation rate for most of our trade partners and countries in the region has shown upward trend. The headline inflation was 2.8 percent in the US and 2.1 percent in the Euro area in September 2007 as compared with 2.7 percent and 1.9 percent respectively in June 2007. Amongst our Asian trade partners, consumer price inflation in China, Thailand, and Indonesia increased to 6.2 percent, 2.1 percent, and 7.0 percent respectively in September 2007 from 4.5 percent, 2.0 percent, and 6.3 percent in June 2007. The consumer price inflation in India stood at 6.6 percent in October 2007 as compared with 5.7 percent in June 2007. Two consecutive floods in July-September 2007 and the devastating cyclone (Sidr) in mid-November 2007 including holdback in export demand, labour unrest, and shaken business confidence acted as significant impediments to GDP growth, aggravated the supply disruptions, and fueled inflation during the period. To face the post-flood and postSidr crises, Bangladesh bank has raised the target for disbursement of agricultural credit by 32 percent to Tk. 83.7 billion and has taken steps to ensure smooth flow of credit to small housing, women entrepreneurs, and to other productive sectors. Meanwhile, about Tk. 5.7 billion has been disbursed under the Small Enterprise. To boost up the activities in the housing sector Bangladesh bank has introduced a housing refinancing scheme of Tk. 3.0 billion to meet the credit demand of middle and low income groups. Special credit facilities have also been arranged for fishing and timber businesses under the post-Sidr reconstruction and rehabilitation programmes. The disbursement of agricultural credit went up to Tk. 25.0 billion during JulyNovember 2007 compared with Tk. 17.5 billion during the same period of the last year.
RECENT EXTERNAL SECTOR DEVELOPMENTS
Given the present comfortable foreign exchange reserve position, the appreciation of Taka would contribute towards easing the inflationary pressure at least in part by discouraging the pass through of international prices on domestic inflation. Nevertheless, recognizing the multidimensional nature of current inflationary forces, Bangladesh Bank will make the best possible real-time judgments regarding the extent to which the recent developments in the external sector are likely to affect economic activities during the rest of the period of financial year 2008.
RECENT MONETARY DEVELOPMENTS
Bangladesh Bank has been following a monetary policy stance since second half-financial year2005 aimed at containing demand side pressures that contribute to inflationary build up in the economy. Despite significant pressure from rising prices in the international market and production shortfalls of major commodities in the domestic economy, an upward revision of the policy interest rates and reintroduction of Bangladesh bank bills in financial year 2007 helped in limiting inflation at 7.2 percent, which is not far off the targeted rate of 7.0 percent for the year. However, the growth in broad money at the end of June 2007 exceeded the target (actual of 17.0 percent as against the target of 14.7 percent) and the growth rate of private sector credit was 15.1 percent compared with the programmed rate of 13.9 percent and the previous year’s growth rate of 18.3 percent. The net foreign assets of the banking system maintained its growing trend, which helped to build up the foreign exchange reserves that reached US Dollar 5.5 billion by the end of first half financial year 2008. Keeping in view the price situation and enhanced excess liquidity emanating from the moderated demand for private sector credit and increase in net foreign assets, Bangladesh bank pursued growth supportive monetary policy stance in first half financial year 2008.
Table 4: Trends in Private Sector Credit
MONETARY POLICY STANCE FOR SECOND HALF-FINANCIAL YEAY 2008 A BRIEF REVIEW
In view of the urgent need to build smooth adjustment capacity to the internal and external shocks that the economy has faced during first half financial year 2008, the monetary policy stance for second half financial year 2008 would aim at bringing about a qualitative change and a
perceptible strategic shift in monetary policy formulation and its conduct to allow greater scope for supporting growth enhancing policies in line with the emerging developments and requirements of the economy. The efforts would be directed at gearing up economic activities by encouraging adequate credit flows to all productive sectors, especially to agriculture, infrastructure, and other rural activities, for recouping the losses due to floods and cyclone and improving the domestic supply situation. The policies would also facilitate the import of essential commodities to ease the shortages in the domestic market. However, with expected increase in economic activities in the coming months, the demand for credit may go up and if such a situation arises, the policy stance would be to contain the demand side pressures without hurting the investment demand in the economy.
The monetary programme and consistent targets for reserve money and broad money expansion for financial year 2008 would be set using the new targets for real GDP growth and inflation. The long-term interest rates have already started to fall in the first half of financial year 2008 despite high inflation. This shows lower inflationary expectations and is an indication of the prudent policy stance of Bangladesh bank. The overnight money market and other short-term rates have experienced a remarkable stability and remained relatively unchanged. For liquidity management, BB would use appropriate policy instruments when needed. In the past, Bangladesh bank has urged the banks to reduce their lending rates and improve the situation so that the high cost of borrowing does not put undue pressure on investors. Bangladesh bank would continue its efforts to lower lending rates, increase competition among the financial intermediaries, and urge the banks to use the excess liquidity to expand their credit operations. Bangladesh bank would continue to pursue strong monitoring and supervision measures so that financial institutions reduce administrative cost by improving managerial efficiency and reducing the burden of non-performing loans.
For successful implementation of the policy stance during second half-financial year 2008, it would be critical to achieve greater fiscal and monetary coordination such that the imperatives of the monetary policy stance are clearly recognized within the policy framework and the relevant policy parameters are aligned with their projected values ensuring macroeconomic stability and rapid growth. Rapid and effective measures of rehabilitation in the flood and cyclone affected areas are crucial such that the adverse impact of the disasters are mitigated within the shortest possible time, production losses are recouped at least partly, and the supply of agricultural and other products increases to create positive effect on food and other essential commodity prices.
There are several factors that would be critical to effective monetary management under the policy stance during second-half financial year 2008:
Re-evaluation of the present subsidy policy because of rapidly escalating subsidies on energy products due to surging oil prices in the global market. Power, transport, and other infrastructure constraints affecting production and other economic activities. Business confidence to accelerate investments and production activities. private sector
Impact of phasing out of restrictions in 2008 on textile exports of China; and Reasonable socio-political stability, and continuity of policies in the backdrop of general elections scheduled in late 2008.
Bangladesh bank, on its part, would remain vigilant regarding the above and any other unexpected developments and unfolding situations. The availability of new data and information may necessitate the revision and adaptation of some of the monetary instruments presented
in this monetary policy statement using the flexible framework of the monetary policy stance for the period second half of financial year 2008 with the aim to promote rapid growth with price stability and support accelerated pace of employment creation and income generation for the people of Bangladesh.
Official cash rate
Consumer’s price index inflation expectations
Consumer’s price index inflation
Trading partner inflation
Figure: Monetary policy process by Bangladesh bank
CONCLUSION, BIBLIOGRAPHY, REFERENCE
Working out where the economy is going has always been crucial to monetary policy, even before the current official cash rate and low inflation system. The advent of digital computers made it possible to build considerably more sophisticated mathematical models. As already mentioned, attaining and maintaining the highest sustainable output growth towards rapid reduction of pervasive poverty is the overriding priority for monetary and other macroeconomic policies in Bangladesh. Monetary and fiscal policies have significant mutual impact, and are therefore formulated and conducted in a mutually consistent and coordinated way with reference to the Medium Term Macroeconomic Framework in attaining the growth, price stability and poverty reduction objectives. The tightened monetary stance now being pursued is intended not to slowdown output growth but to curb excess demand arising from inflationary expectations, thereby supporting sustained stable output growth over the near and medium term. The fourteen percent growth of credit to the private sector programmed for financial year 2006 would be sufficient to support seven percent real GDP growth if Consumer’s price index inflation is seven percent; even higher real GDP growth will be supported with lower inflation. The monetary stance is subject to continuous review in the light of evolving situation, may shift to a neutral stance, and may even move further to an accommodative stance as values of key macroeconomic variables change.
Shekhar.K.C and Shekhar Lekshmy; Banking theory and practice; 18th revised edition, Vikas Publishing House PVT LTD.
1. www.BangladeshNews.com.bd 2. www.BangladeshBank.com.bd 3. www.Banglapedia.com
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