Green University of Bangladesh

Department of Business Administration

Course Name
Macroeconomics
Course Code
ECO-201
Assignment - 02
Assignment on
Monetary Policy of Bangladesh and Its Impact on Economy
Submitted To

Mr. Zaved Mannan

Senior Lecturer and Assistant Program Coordinator (MBA Program)

Submitted By

########

Group – 02

Date of Submission - /4/2014.

 Acknowledgements

Firstly I would like to thanks almighty Allah and then many thanks to Mr.
Zaved Mannan (Senior Lecturer and Assistant Program Coordinator) for giving me the
opportunity to make this report on “Monetary Policy of Bangladesh and impact
on economy” .

Thanks to the University (GUB) Computer Lab for providing a nutritious

environment for completing this report. Also I like to give thanks especially to
my friends and many individuals, for their enthusiastic encouragements and
helps during the preparation of this report us by sharing ideas regarding this
subject and for their assistance in typing and proof reading this manuscript.
Contents
Introduction

Definition of Monetary Policy

Scope of monetary policy

Objectives of monetary policy

Exchange Rate Stability

Full Employment

Neutrality of Money

Equal Income Distribution

Objectives of Monetary policy in Bangladesh

Tools of monetary policy

Monetary policy of Bangladesh

The likely impact of monetary policy on private investment

Conclusion

References

http://www.asaub.edu.bd/data/asaubreview/v7n1sl1.pdf

http://dspace.bracu.ac.bd/bitstream/handle/10361/1508/Monetary%20Policy%20and%20Money
%20Supply%20Process-Aminul%20Islam.pdf?sequence=1

http://www.scribd.com/doc/60816069/MACRO-Economics

http://www.studymode.com/essays/Monetary-Policy-Of-Bangladesh-And-Its-362681.html

http://www.bb.org.bd/monetaryactivity/mps/mps.php

http://thesis4all.com/tag/bangladesh-bank/

http://www.docshut.com/mnqtwn/monetary-policy-in-bangladesh.html

www.cpd-bangladesh.org

www.Banglapedia_allbd.com, use Subject: Ref-Banglapedia.SBD M_0309.htm

Introduction

Monetary Policy 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. With the shifts of the policy
stance of the government in various phases, necessary a d j u s t m e n t s w e r e m a d e i n t h e
country's monetary policy. T h e D e p a r t m e n t o f Research in the Bangladesh
B a n k p l a y s a n i m p o r t a n t r o l e i n t h e f o r m u l a t i o n o f economic policies of the country.
The principal function of the Department is to help the bank in the formulation
of monetary and credit policies and also to assist it in discharging its duty as adviser to the
Government on economic and financial matters. To this end, the department keeps the
top executives of the bank fully informed of latest economic development both at home and
abroad, in a regular and systematic manner. For this purpose the Department keeps a
close watch on trends in the domestic economy as well as on international economic
developments with particular reference to monetary, fiscal and trade problems and policies .
Domestic and international economic developments are brought within the compass o f
comprehensive reports and reviews which are submitted for perusal of the
Governor, Deputy Governor, and Senior Executives of the bank, as also the bank’s Board of
Directors.

Definition of Monetary Policy

Monetary policy is the term used by economists to describe ways of managing the supply of money
in an economy. Monetary Policy is the management of money supply and interest rates
by central bank to influence prices and employment for a c h i e v i n g t h e o b j e c t i v e s o f
g e n e r a l e c o n o m i c p o l i c y . M o n e t a r y p o l i c y w o r k s t h r o u g h e x p a n s i o n or
contraction of investment and consumption expenditure.
According to Paul Einzig “Monetary 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.”
According to Harry G. Johnson “Monetary policy employing the central band’s control of supply of money
as an instrument for achieving the objectives of general economic policy.”
According to G.K. Shaw “By monetary policy we mean any conscious action undertaken by the
monetary authorities, to exchange the quantity, or cost (interest rate) of money.”
From the above discussion monetary policy may be defined as the central bank’s policy pertaining to the
control of the availability, cost and use of money and credit with the help of monetary measures in order to achieve specific
goals.
The regulation of the money supply and interest rates by a central bank, such as the Central Bank of
Bangladesh in order to control inflation and stabilize currency. Monetary policy is one the two ways
the government can impact the economy. By impacting the effective cost of money, the Bangladesh
Bank as a controller of monetary policy can affect the amount of money that is spent by consumers
and businesses.
Monetary policy is the 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.
a) the supply of money,
b) availability of money, and
c) Cost of money or rate of interest to attain a set of objectives oriented towards the growth and
stability of the economy.
d) Monetary theory provides insight into how to craft optimal monetary policy.

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.

Objectives of monetary policy

The objectives of a monetary policy in Bangladesh aim at growth, stability and social justice. After
the Keynesian revolution in economics, many people accepted significance of monetary policy in
attaining following objectives.

 Rapid Economic Growth

 Price Stability
 Exchange Rate Stability
 Balance of Payments (BOP) Equilibrium
 Full Employment
 Neutrality of Money
 Equal Income Distribution
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.

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 BB 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.

Objectives of Monetary policy in Bangladesh

As stated in the Bangladesh Bank Order 1972, the principal objectives of the country's monetary
policy are
1. To regulate currency and reserves;
2. To manage the monetary and credit system;
3. To preserve the par value of domestic currency;
4. To promote and maintain a high level of production, employment and real income; a
5. 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.

Tools of monetary policy

Major instruments of monetary control available with Bangladesh Bank are the bank rate, open
market operations, rediscount policy, and statutory reserve requirement.
The methods of credit control can be classified as follows:
Quantitative/ General Methods Qualitative/ General Methods
01. Bank rate policy 01. Rationing of credit
02. Open market policy 02. Direct action
03. Variation of reserve ratio 03. Regulation of consumers’ credit
04. Moral persuasion
05. Publicity

Monetary policy of Bangladesh

1. The lending rate of banks, which had come down to single digit or low 2 digits, is rather high now,
nearing 16-20 per cent depending on nature of loans.
2. Although Bangladesh Bank (BB) has been pursuing a contractionary monetary policy, the
government of Bangladesh has been pursuing an expansionary fiscal policy, mainly on account of
safety nets and subsidies. The contractionary monetary policy has reduced the total loan able funds in
economy. The government deficit has further shrunk the funds available for private sector lending.
This has led to crowding out of investments. Such policy if sustained in the long run can raise the cost
of borrowing.
3. Bangladesh being an import-led economy, contractionary monetary policy coupled with consistent
devaluation of taka is taking a big toll both on producer and consumer welfare. Producers are being
affected as their productivity is hampered due to rising costs; consumers are affected as producers
pass on costs to consumers.
4. In the coming days, it is expected that the import payments towards meeting the energy needs of
the country will be high. A high interest rate policy is counterproductive to improving the domestic
productive potential of the economy. It also makes local industry less competitive, thus reducing the
scope for import substitution by setting up local industry.
5. With the passage of time, the age old differences between real and non-real financial activity is
coming down. While traditionally banks have been the main source of finance for industrialization,
the capital market has emerged as a viable alternative for entrepreneurs to seek capital. Public
companies have more open books of accounts and pay more taxes than non-listed companies. They
also share the profits with common citizens who receive dividends as reward for investing in the
companies. The capital market also mitigates the needs for companies to seek capital from banks
hence reducing interest rates.
6. Industrialization in Bangladesh is still in its infancy. Worldwide governments are helping local
producers by offering them tax breaks, cash incentive, subsidy etc. Yet, even rich countries attach
conditions when giving aid that the procurement for machinery/expertise should be made from the
donor country.
7. The year 2012 the world is seeing a continuation of the 2008 economic crisis. The effects of
devaluation are already worsening domestic inflation. Making capital costly will further discourage
domestic investment in industry. This will not allow the country to augment its production possibility
frontier. Hence domestic industry will also lose its incentive and competitiveness which in the long
run can only worsen the balance of payments situation as imports increase to fulfill the needs of a
growing population.
8. BB should coordinate with the government on policy matters. As I have mentioned earlier the
policy goals of BB and GOB need to be aligned, otherwise it can cause financial devastation.
9. The BB governor keeps stressing the need to reduce credit flow towards non-productive sectors. In
free market such distinctions are unwarranted. The role of state and government should be that of a
facilitator. BB is trying to modulate the consumption of citizens which it should not do. It is only
encouraging the government in the process of increasing welfare payments, hence rising deficit.
10. In light of the above and the continued global economic crisis, BB may soften its stance on credit
supply. It can seek to ensure financial sector strength, by asking the banks to further recapitalize
themselves. For that again Banks will need to go for the right offers, which are best induced by a
stable gradually rising capital market.
11. BB and the present government must get over old 'socialist' ghosts from deciding the crux of
economic policy. Real welfare cannot be ensured by policy alone. For instance, in spite of the
continuous supply of agri-credit by BB, farmers remain underfed, underemployed, under rewarded,
although retail prices of their produce go higher! This is a direct result of market distortion in which
both BB and the Government of Bangladesh have a role to play.
12. The Government should allow citizens new ways to seek capital and also with discretion invest
abroad, just like numerous foreign companies are repatriating huge amounts of dividend in local
investments every year. Such international expansion of local companies will result in ensuring future
capital inflows into Bangladesh.
13. Excessive controls on capital flow from outside the country have resulted in distortion of currency
markets and given primacy to the role of informal money transfers and dealings. BB and the
Government of Bangladesh should set up a prudential strategy to encourage more foreign currency
inflow. Tax breaks to multi-national companies which operate in Bangladesh should be conditional on
reinvestments of capital locally. Capital repatriation out of the country should be discouraged through
policy and counselling.
14. Presently the ‘Cushion Against Risk’ of Bangladeshi banks is only 9% against an average of 14%
for India, Pakistan and Sri Lanka. High cost of credit will further deteoriate the asset quality of banks,
leading to higher defaults and even trigger a banking crisis. The depository insurance policy of BB is
inadequate to protect the depositors’ interest. For instance., recently the Iranian currency depreciated
by as much as 40% against the US dollar as a result of sanctions. In such volatile economic times, we
have to do everything to save and encourage domestic industry. Industry cannot flourish and sustain
with lending rates of banks/non-bank financial institutions reaching 16-21 per cent.
15. Presently the real estate sector in Bangladesh is still drawing a lot of investment. NRBs need to be
discouraged to invest in real estate and focus on creation of industry/agriculture/service sectors. Also
to prevent excessive lending in real estate, BB should make housing sector loans adjustable. This is
followed in Australia which has helped Australia to escape from fallouts of the subprime crisis that
has incited the present global economic collapse.
16. BB needs to work with the Government to allow Bangladesh to seek alternative capital from
abroad to reduce the dependence on multilateral lending agencies such as the World Bank/IMF. While
these aid/loans offer lower interest rates, the policy conditions can in the long run impose huge costs
on local economy. For example, presently Malaysia has zero borrowing from World Bank/ IMF. BB
can recommend GOB to go for further pursue government to government negotiations with
Islamic/other countries that have surplus capital. Malaysia is the perfect example of development
using foreign financing.
17. Monetary policies need to be used with much care in a low income country like Bangladesh where
narrow money use is still wide. Contractionary monetary policy coupled with expansionary fiscal
policy will fail as government goes for money printing to finance deficits, again triggering inflation.
BB needs to use its policy tools to allow further recapitalization of Bangladeshi banks, which are
mostly private. To do so, banks need to entice investors by making good profits. BB has to accept it’s
a better trade off for whole economy that the banks make money, not BB making money at the
expense of the banks, by imposing tight statutory conditions such as higher Statutory Reserve
Ration/Cash Reserve Ratio. Rather BB should advise the government on using Keynesian fiscal
policies in times of economic stress to stimulate employment and growth. For instance right now,
apparently the food reserve is very comfortable for government. Government can go for labor
intensive policies such as canal digging which will reduce food inventory and allow the government
to go for fresh rice procurement that will ensure fair price to farmers.
18. In a more sophisticated world, BB needs to protect itself and Bangladeshi banks/importers from
suffering losses in foreign currency transactions. Thus BB should explore and encourage hedging of
trades done by local importers/exporters.
19. BB should establish a joint venture export import bank of Bangladesh to assist trade finance of
Bangladesh. This will allow the country to save a huge amount in advising fees that are paid to
foreign banks that eventually increase the cost of trade.

The likely impact of monetary policy on private investment

The recently announced six-monthly Monetary Policy Statement (MPS) by the Bangladesh Bank
indicates that the monetary policy in Bangladesh has so far restrained the growth-conducive
productive economic activities by way of limiting access of the private sector to credit and lowering
the import of raw materials, intermediate goods and capital machinery.
The new monetary policy has been announced when the economy of Bangladesh is confronted with
the problems of a slowed-down growth rate of its gross domestic product (GDP), decline in
investment, depreciation of Taka, continuation of inflationary pressure, and faux-pas in fiscal
management. No restrictive or contractionary monetary policy can address such problems effectively,
more so more in developing economy like that of Bangladesh.
The central bank has termed its current half-yearly MPS as 'balanced' monetary policy. This is for the
fourth time in a row the Bangladesh Bank has otherwise been pursuing such a monetary policy which
is, by essence, contractionary in nature, though it has variously styled those policies as 'restrained,'
'expansionary' 'balanced' etc.
The recently-announced MPS has targeted to ensure access to credit and promotion of the growth-
conducive productive economic activities through the twin measures of increasing private sector
credit by only 0.5 per cent and reducing all repo rates by 50 basis points. This is a matter of concern
that during the last six months the availability private sector credit was at the lowest in the last four
years and even this target the lowest one has not been achieved.
Private sector credit increased by 17.41 percent in November 2012 against the target of the related
monetary policy at 18.3 percent. It is also found that the access to credit during the rest five months of
this fiscal year is not sufficient to achieve the annual 7.2 per cent growth rate of GDP.
Net domestic assets increased by Tk. 541.796 billion or 13.47 per cent in November 2012, compared
to November 2011. On the other hand, net foreign assets increased by Tk. 320.499 billion (51.35 per
cent) in November 2012, compared to November 2011.
The goals of an inflation-targeting MPS alone, without considering the needs for proper fiscal
management, is not are well-nigh impossible to achieve. The lower international food price has been
the main reason behind the lower rate of food inflation for a considerable period of time until recently
in Bangladesh whereas non-food inflation has been increasing. Moreover, the observed moderation of
inflation from a peak of 10.96 per cent in February to 8.74 per cent in December 2012, though still
high, cannot be attributed by any means to any contractionary monetary policy. On the other hand,
non-food inflation increased from 11.15 per cent in June to 11.45 per cent in December, 2012.
There is also a negative impact of a tight monetary policy on import of intermediate goods, industrial
raw materials and capital machineries. Imports of capital machinery and industrial raw materials fell
by 28 per cent and 6.31 per cent respectively during July-November period of the current fiscal year,
considering the settlement statistics in Bangladesh.
The growth prospects of the economy may be adversely affected while the failure in meeting export
targets may also pose a challenge to the attainment of the GDP growth target. In the month of
November 2012, total export earning stood at USD 1765 million against the corresponding target of
USD 1990 million -- a shortfall of 11.35 per cent.
In the month of November 2012, most of exports showed a downward trend of growth. In the month
of October 2012, export earnings from tea, fish & shrimp, readymade garments (including knitwear
and hosiery), fertiliser, and others (including EPZ) decreased by Tk. 10 million, Tk. 2210 million, Tk.
11640 million, Tk. 1290 million and Tk. 3400 million respectively compared to the corresponding
figures of October 2011.
The exchange rate of Taka has not been stable yet, in spite of purchasing 2.6 billion dollar by the
Bangladesh Bank to increase the reserve money. It is to be noted that the depreciation of Taka against
USD raised the value of import bills (measured in Taka) which induces trade deficit. During the last
six months of the current fiscal year, the average exchange rate of Taka against USD was Tk. 81.39 --
Tk. 5.49 more than that of the same time of the previous fiscal year.
Moreover, it can be added that the increasing savings-investments gap, the short-sighted fiscal-
monetary policy mix stipulated in the IMF-MEFP, inflationary pressure and confrontational politics
may hinder attainment of the desired level of growth in fiscal year (FY) 2012-13. For FY 2012-13, the
government targeted a 7.2 per cent rate of growth in GDP.
The lending rate has been increasing more than that of the deposit rate, albeit with a higher gap
between these two rates of interest. This hinders private investment. The spread on lending and
deposit rate expanded to 5.41 per cent in November 2012 from 5.23 per cent of November 2011. To
implement its monetary policy, Bangladesh Bank increased its rate of lending by 0.33 per cent in
August, 0.23 per cent in September and 0.11 per cent in November of FY 2012-13 over the same time
of the previous fiscal year.
Private sector investment has already slowed down due to the higher lending rate. On the other hand,
after adjustment for the rate of inflation, the real rate of interest on deposits becomes much lower than
the nominal one. Depositors thus continue to supply loanable funds at lower costs in real terms to
banks. The letter are in a better position to reap gains out of this situation.
Implementation of the current monetary policy might face some major macroeconomic challenges by
way of not facilitating expansion of investment activities at the desired level. Such a monetary policy
can hardly serve the real needs of the economy. Rather, it has the potential to widening further the
savings-investment gap.

Conclusion

The Monetary Policy Statement (MPS) is intended to outline the objective and the modalities of
formulation and conducting of monetary policies by the Bangladesh B a n k , i t s a s s e s s m e n t
o f t h e r e c e n t a n d t h e e x p e c t e d m o n e t a r y a n d p r i c e developments, and
the stance of monetary policies that will be pursued over the near term .Objectives of the
monetary policies of the Bangladesh Bank as out lined in the Bangladesh Bank Order, 1972 comprise
attaining and maintaining of price stability, high levels of production, employment and economic
growth. In such a d i r e c t e d r e g i m e w i t h l i t t l e o r n o r o l e o f f i n a n c i a l p r i c e s
i n i n f l u e n c i n g t h e magnitudes or directions of credit the present MPS (Monetary Policy
Statement) provides the monetary policy stance that BB (Bangladesh Bank) intends to follow during
the second half: January to June (H2) of FY08. The prime objective of the policy stance is to
ensure the use of the financial instruments towards promoting real sector growth at its targeted
level along with ensuring 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 FY08.