The Bangladesh Bank recently released its monetary policy statement (MPS) detailing its plans for the second half of fiscal year 2017-18, that is, January to June 2018.
During this critical period, the central bank should apply all its monetary tools to achieve the targets it has set for itself in terms of broad money, net domestic and foreign assets, inflation and interest rates, etc. Only by meeting those targets can we ensure the kind of economic performance we have been anticipating.
Prudent monetary policy management and fiscal discipline together support macro-economic stability, allowing the economy to benefit from favourable external demand, high remittance inflows, high export growth and low commodity prices, all of which help to make our economy stronger and more resilient to external shocks.
There are some vital economic indicators that can guide us as to whether or not monetary policy is working as intended. Those are: GDP growth, inflation, interest rate, excess liquidity and money supply, clarity in deposits and non-performing loans, advance deposit ratio, etc.
Other indicators include the exchange rate, productive investment, capital adequacy, current account and trade balance, forex reserve position, private and public sector credit, borrowing by government, etc.
Some important factors to consider when analyzing these indicators are: Efficiency of state-owned enterprises, institutional accountability, job employment opportunities, cost of doing business, political risk, elections, etc.
Laying the groundwork
The country’s economy is, at present, beset with major challenges, so that before we can see the sustained results that monetary policy can produce, we have to be prepared to lay the necessary groundwork first. Doing so would entail some short-term costs but will help us immensely in the long-run, especially since not doing so would almost certainly threaten our future progress and stability.
For instance, a strong and healthy growth propelled by increased private and public investment along with public spending can lead to higher investment-related imports, pushing the current into a modest but manageable deficit. But the returns from those investments will bring us back to equilibrium. It’s also a good idea to keep the public debt-to GDP ratio at moderate levels while working to raise the revenue-to GDP ratio.
Given existing challenges like an increasing savings-investment gap, unsatisfactory collection of tax revenue vis–a-vis target resulting in revenue short-fall, infrastructural under-development, institutional weakness, and slow-down in investments, to name a few – maintaining the current rate of output growth would require not only prudent macro-economic policies, but also upgrading the macro-economic policy-making practices and institutions.
It is essential to restore discipline and balance in the financial sector if we want to achieve our country’s dream of becoming a knowledge-based, middle-income country by 2021, and eventually, eradicate poverty and ensure overall development of people’s living standards.
Managing problem areas
A strong financial system is a must for successful implementation of monetary policy.
Now, the running crisis in the banking and financial sectors due to a staggering increase in non-performing loans reflects institutional weakness in our financial system, which needs to be addressed.
The increasing gap between investment and savings is a major red flag indicating illegal capital flight.
The huge amount of missing funds representing an unaccounted transfer of money is a big blow to the economy as it means loss of investment and revenue income for the government.
These are some of the issues with our system that must be looked into for monetary policy to be effective.
Key indicators to watch
Our monetary policy should therefore be designed in a way that it keeps some key indicators on track.
Inflation, which took an up-turn in July 2017 and climbed to 5.59% by December 2017, is one of those indicators.
Some economists predict far higher inflationary pressures in the near term as the country is facing some supply-chain problems with rice in addition to last year’s floods that caused severe crop damage and lower productivity. Embracing a flexible inflation targeting approach is a possible solution.
As for interest rates, the declining trend coupled with higher inflation is creating ample liquidity and an increase in competition in the banking systems, where spreads between lending rate and deposit rate should be kept at a reasonable and minimal level.
Private sector credit growth is slightly on the rise but still very low. If we want to achieve our desired rate of GDP growth, private sector credit should be accelerated somehow.
The current account and trade balance recorded a deficit due to higher import growth relative to export growth, and slow-down of remittance inflows during the last couple of months.
As a result of deterioration in the balance of current account and trade balance, unsatisfactory performance occurs that could be improved by adopting a cautionary and consistent monetary policy.
To promote financial stability with sustainable development of banking and financial institutions, a sound, comprehensive, and effective monetary policy is needed to optimize all the different indicators which help the economic growth of the country.
The central bank needs to consider the effects of the welfare-oriented government budget and private sector investment on prices and the external sector stability.
Likewise, it is necessary to appropriately manage the existing excess liquidity in the banking system in order to support development activities and investment promotion.
Excess liquidity, low interest rates and interest rate differential with the neighbouring economy are some of the challenges facing the economy.
If this situation prevails for long, it could be disastrous for the economy, because such a scenario is ideal for informal capital flight, dominance of imports along with luxurious consumption and increasing speculative businesses, all of which eventually make the country worse-off.
Considering the likely impact of such a situation on financial stability, monetary policy must focus on managing liquidity, inflation rate and interest rate at an appropriate level and channeling the financial resources towards productive sectors that benefit the whole nation, not just the wealthy elite.
Under the current backdrop of low levels of financial inclusion, limited access to financial services, and low levels of financial literacy among the general public, especially in remote, rural, and high poverty areas, utmost priority must be given to address these concerns.
Abdus Sobhan is a deputy general manager at Bangladesh Krishi Bank. He may be reached at: [email protected]