Did tight monetary policy help?

With support from the World Bank and more importantly the IMF, the Bangladesh Bank (BB) has largely improved its policy analysis capability. The regulator has been announcing the half-yearly monetary policy statement (MPS) since 2007.

Monetary policy is generally either expansionary or contractionary. When the total supply of money is increased, it is expansionary, and when cumulative money supply is decreased, it is contractionary. An expansionary policy is usually adopted in a situation where employment generation is a priority by lowering interest rates. Conversely, a contractionary policy is followed to stabilise inflationary pressure through increasing interest rates.

There's also an "accommodative" stance—a balancing act between curbing inflation and supporting growth, marked by relatively swift shifts in policy direction.

Since its inception, monetary policy in Bangladesh was conducted with full direct control on interest rates and exchange rates, also on the volumes and directions of credit flows. But today, direct lending (other than loans at times directed by the state-owned bank's board) has mostly been abolished, and gradual liberalisation of interest rates has taken place.

The exchange rate has become floating, with BB buying or selling currencies to keep liquidity at the desired level, though we heard about "managed float" or "moral-suasion" at frequent intervals.

BB's recent MPSs have focused on identifying and neutralising inflationary pressures arising from growth-supportive policies, while still targeting priority sectors like agriculture, SMEs, renewable energy, and green finance. At the same time, it has discouraged lending to unproductive or consumption-heavy sectors.

Though BB has often framed its strategy as accommodative, in practice, it leaned towards contractionary, mopping up excess liquidity by raising the cash reserve ratio (CRR) and policy rates. Liquidity was occasionally injected through repurchase agreements (Repo) to ease the market.

BB aimed to shield the banking sector from shocks like a stock market crash. But political instability and policy contradictions, such as legalising black money in real estate, capital market, or extending support to struggling apparel firms, undermined its efforts. These moves increased pressure on the central bank's policy credibility.

Adding to the strain were rising loan defaults in state-owned banks and poor supervision of classified loans, including pressure to release reserves  made against classified loans. This impacted the liquidity situation.

At its core, BB is more responsible for real sector growth while maintaining banking sector stability. But a shallow capital market, with only about 300 traded issues, not depicting the real fundamentals, cannot ensure inclusive and equitably distributed growth.

In a labour-surplus economy like Bangladesh, job creation, with an increasing rise in investments, is crucial. Only real sector investment can make it happen.

Managing the trade-off between controlling inflation and supporting growth is a tough balancing act. BB must remain cautious about private sector credit growth and avoid extending credit to unproductive sectors. Equally critical is addressing rising debt default and maintaining exchange rate stability.

That said, in a country with weak governance, tackling inflation is more about enforcing rule of law than monetary tools alone. Excessive focus on lowering inflation can choke off investment and stall national wealth creation. Interest rate management is vital in this context.

Our economy is offering policymakers all the challenges of "managing growth in a transition economy" with an apparently weak regulatory framework and pressure on capacity. Even if we perform above average, striving continuously to maintain a balance with fiscal measures, the country does not have a high risk of slipping from the growth track. If we err, let us err with investment and employment generation.

The writer is an economic analyst and chairman at Financial Excellence Ltd