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Policy rate hike and depreciation |
Bangladesh Bank at one fell swoop raised the policy rate by 50 basis points and depreciated Taka against the US dollar by Taka 7. The decision was taken at the last moment of negotiations between Bangladesh Bank and IMF to get the third instalment of $4.7 billion credit package. The decision is met with mixed reactions. Some argued it may increase the cost of borrowing money and doing business. Concerns are also raised over likely increase of prices of fuel and other essentials,resulting from latest round of depreciation.
Inflation in general is still around 10%(9.89% officially). Food inflation is much higher than that. But the policy rate now is 8.50%. That means real interest rate is -1.39%. So Bangladesh Bank has to raise interest rate further. Hopefully at the end of this month, there will be another hike in policy rate. Then in June when another Monetary Policy Statement (MPS) will see the light, we will surely see another rise in policy rate. The gradualism ,as I construed, is being pursued not to hurt the employment. Businesses and export-oriented industry depend on credit to finance their working capital. Many will simply shut operations, rendering millions of workers unemployed,if there is a drastic increase in policy rate. There will be a chaotic situation to handle. Moreover, this latest rise will also raise the deposit rate, drawing the idle money that lies outside the banking system. Federal reserve systems decision to continue the interest rate hike and Russian and Chinese billionaires dollar buying spree in the face dollar ban at home complicated the matter. Dollar deposit outside the country is more lucrative and rational right now. It is not right to blame the business groups indiscriminately for hedging their money abroad. In that light BB's policy rate hike is a must and it should be continued to make Taka deposit attractive.
My understanding is that the depreciation of taka was necessary to ease the pressure on printing money to finance development program and to meet the revenue shortfall. Now the central bank will sell the forex to banks at new exchange rate. If it sells $1 billion dollar from its existing reserve then it will bag Taka 7 billion from this transaction. Earlier this Taka 7 billion may be generated through artificial demand of issuing treasury bond or "devolvement ". But it is now generated through market mechanism. At the same time, bank stopped giving 2.5% incentives to remitters as the new exchange rate is pretty much in line with the market exchange rate. For $1 billion worth of remittances,central bank has to provide Taka 292.50 billion to remitters. So central bank does not need to inject this Taka 7 billion plus 292.50 into the economy. At the end of the year the figure saved will be much larger. This depreciation will stem future inflationary pressure. The pass-through effect on fuel price will be miniscule. On April 16, crude oil price was $85 per barrel. On May 10, it is $ 79 per barrel. That means in one month crude oil price is lowered by $6 per barrel,a 7% reduction. Bangladesh is pursuing a monthly market-based fuel price adjustment. Meanwhile, crawling peg requires weekly adjustment of exchange rate. Exchange rate will be adjusted 4 times in a month in the face of a monthly fuel price adjustment. This time we see a 6.36% depreciation. So 6.36% increase in the price of US dollar is largely offset by 7% reduction in oil prices. This clearly indicates that pass-through effect on fuel prices and related to other cost is negligible. Moreover, depreciation allowed government to increase its revenue target through import duties,which accounts a large part of revenue earnings. It will clearly augment Taka amount of revenue earnings and thereby increase revenues' percentage share of GDP. Depreciation throws cold water to foreign remittance houses' plan to make gains from appreciation of Taka that they stockpiled previously.I wrote a detailed piece back in November last year about it.(For more read "Exchange Rate Volatility:Policy Debacle Should Be Blamed",Rezaul Hoque,https://hoquestake.blogspot.com,November 17,2023. link:https://hoquestake.blogspot.com/2023/11/exchange-rate-volatility-policy-debacle.html?m=1 )
In December of 2023 and first three months of 2024,Pakistan witnessed growth in RMG export earnings. In January the growth was 10% and in February it was 19%.( For more read "Pakistan's Textile Export Up 3% YoY in March,Clock In At $1.3 Billion", Business Recorder,link:https://www.brecorder.com/news/40296824 ) During the last three months of 2023 Bangladesh witnessed negative growth in export earnings in the US market. Pakistan depreciated its currency to a great extent. It is reaping benefit from it. Luckily, delayed depreciation will bring back some export orders from our competitors and will help Bangladesh regaining its US market share.
The twin actions of Bangladesh Bank is a belated and much anticipated move. It is the high time to bring the economy back on track through much needed policy adjustment. Despite the criticism, this right move will correct some of the wrongs of the past and hold back government spending.
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