Could MPS2 Contain Inflation?

First monetary policy missed the target, Next one should not be a reason for regret.

The central bank is planning to introduce another Monetary Policy Statement(MPS).As anticipated, it is going to raise again the policy rate. Earlier it had raised both the repo and reverse repo rate by 25 basis points in line with gradualism. This time too it is likely to do so ,but interest rate increase may be more than 25 basis points. In the previous MPS, inflation target was set at 7.50%. However, inflation is around 9.94% according to govt statistics. Since primary concern is checking inflation, more drastic steps are needed.

In the previous piece, I highlighted how govt is accelerating inflation.Sharing parts of it again¹:” Central bank is printing the money and lending it to the government against treasury bonds. Central bank is both the legitimate authority to print money and issue treasury bonds and it is not selling the bonds to the banks. But govt is paying the bills of development expenditures and other spending through checkable deposits, which is increasing in volume. This ultimately leads to lower currency-deposit ratio that ends up in higher money-multiplier. So government's intention to have a low money-multiplier is not working. Central bank could do so by increasing the reserve ratio of banks,which is now only 4%². Higher reserve ratio will do the trick.

However, central bank is not doing so as it could curtail the credit to private sector, which is getting less and less amid govt's increasing borrowings from the banks.For the first two quarters of the next fiscal year,it could forget about private sector credit growth. As election is near, investors will await till the next govt assumes power. Meanwhile, higher reserve ratio could lower the money-multiplier."

Bangladesh Bank quarterly tells a lot about this.Money multiplier was 4.92 at the end of FY 22. It then rose to 5.07 at the first quarter of FY23. It then slided down to 4.63. Though reserve money registered a 17% growth at the second quarter of FY23. But it was not good enough to lower the money multiplier.

Meanwhile, public sector credit growth was recorded to be around 25% at Q2 of FY23. But private sector registered only 12.89% during the same period. It is not known how far the situation will improve ahead of election. Negative growth in volume of cargo handled by Chattogram port (-4.56%), a record in the last three years after COVID,gives an aura of sluggish business environment.

This is the right time to raise the interest rate by more than 100 basis points. If everything goes well ,two quarters later inflationary situation may improve. Government is injecting money into the system, it is quite natural that the long-run interest rate will rise in response to such move. Empirical evidence is there. A free and fair election will bring back investor’s confidence and credit flow to private sector will translate into success stories. Until that happens, central bank is in a comfortable position to take some tough stance.

Notes And References

1. " High Inflation And Unjust Tax: Evils Faced By The Middle Class",Rezaul Hoque,June 08,2023,https://hoquestake.blogspot.com For more read at https://hoquestake.blogspot.com/2023/06/high-inflation-and-unjust-tax-evils.html?m=1
2. Bangladesh Bank Quarterly, vol-XX,No-2,October-December 2022