The monetary policy for the latter half of the current fiscal year maintains its established stance, with no significant alterations. This continuity was anticipated, as the policy decisions implemented since the change in leadership at the Bangladesh Bank (BB) last August required no major modifications.

BB anticipates a GDP growth rate between 4% to 5%, a prediction consistent with other experts. Additionally, BB has adopted a pragmatic approach to lowering inflation by approximately 200 to 300 basis points by the fiscal year's end.

This objective is challenging but achievable, particularly if supply-side inflation pressures are mitigated. There are signs that inflation expectations are easing, as evidenced by long-term interest rates falling below short-term rates. It is certainly refreshing to see an official document that broadly reflects the realities on the ground.

A right stance on policy rate

The greatest obstacle plaguing the Bangladesh Bank has been the relentless high inflation. January's data painted a mixed picture: while headline inflation fell by 95 basis points from December, it came with a 6 basis point rise in non-food inflation.

The reduction in headline inflation was solely due to a 220 basis point drop in food inflation, largely driven by seasonal improvements in supply following the winter crop harvest.

It is important to clarify that the decline in food inflation does not equate to a drop in food prices. Rather, it signifies that food prices rose at a slower rate in January 2025 compared to January 2024 than they did in December.

On average, food prices in January were 1.27 percentage points lower than in December, but this decline was more gradual compared to the 2.89 percentage point drop from November.

As usual, the seasonal effects appear to be waning.

Given this context, maintaining a tight monetary policy is indeed justified, despite preferences from the business community for a more lenient approach. The BB cannot afford such a risk with inflation rates remaining unacceptably high. Nonfood prices have risen every month for the past three months, mirroring the trend from the previous year, indicating that inflation has become endemic.

The MPS rightly pointed out "monetary policy has remained excessively accommodative since 2020, as demonstrated by the consistently negative real policy rate. Furthermore, the implementation of a lending rate cap at 9% since April 2020, which remained in effect until May 2024, has undermined effective monetary policy operation in Bangladesh".

Adhering to a 10 percent policy rate for an extended period cannot be the sole strategy to mitigate inflation. Effective inflation management necessitates coordination with other economic policies, such as fiscal policy and market management.

The revised Tk 99,000 crore government borrowing from the banking system, down from the original Tk 137,500 crore, will help the implementation of monetary policy.

It will create space for expansion of private credit without exceeding the domestic credit growth target.

The MPS quotes a BB study in January 2025 which revealed that "proactive measures—such as robust monitoring and oversight of commodity stocks, timely imports before shortages occur, accurate and timely prediction of supply-demand gaps, and rationalization of import duties—could be pivotal in stabilising prices for staple items like rice, wheat, edible oil, potato, and onion".

These fall outside BB's jurisdiction. However, ensuring exchange rate stability without suffering a foreign exchange shortage is central to BB's responsibilities.

Enigmatic exchange rate policy

BB's exchange rate policy is enveloped in ambiguity. The Monetary Policy Statement (MPS) says "BB has been implementing a crawling peg exchange rate mechanism to enhance both flexibility and stability of the rate in the foreign exchange market".

On December 31, the BB issued a circular stating that "Authorised Dealers (ADs) are allowed to purchase and sell foreign currency from/to their customers and other dealers at freely negotiated rates". Interestingly, the MPS added "within the band" which the circular did not have.

The ambiguity is also evident from the exchange rate data posted on BB's website. Notably, the exchange rate page begins with the following statement: "Exchange rates of Taka for inter-bank and customer transactions are determined by the dealer banks, based on demand-supply interaction. Bangladesh Bank (BB) undertakes USD purchase or sale transactions with dealer banks at prevailing inter-bank exchange rates when needed to maintain orderly market conditions".

This may be their aspiration, but it is certainly not reflective of current market practices.

There is a strict ceiling of Tk 122 per USD, which, according to market insiders, is enforced through moral suasion by phone and inspection.

BB itself utilises this rate for buy and sell transactions with the government and international organizations.

Since the new circular's issuance, the highest and lowest USD/BDT buying and selling rates have been fixed at Tk 122/USD. The exchange rates declared by banks hover around this number, making such a peg wholly inconsistent with the jure exchange rate policy articulated in the aforementioned circular.

It is evident that BB is gripped by a profound fear of allowing the exchange rate to float, apprehensive that it may depreciate continuously if left to free negotiation between dealers and their counterparts.

This depreciation is problematic as it would exacerbate inflation. However, it could indeed become a reality if dealers are hampered in their ability to intermediate foreign currencies due to the caps imposed by BB. The inability to offer rates in accordance with market competition undermines the LC market, thereby disrupting international trade.

Reality denied is stability delayed

Bangladesh cannot risk a shortage of gas, liquid fuel, and essential commodities given the fragile state of social order. With summer approaching, the largest single rice crop (boro) at an early stage of cultivation, upcoming festival demand, and less-than-ideal business conditions, the situation is precarious.

Non-transparent arm-twisting of the exchange rate will not prevent inflation from rising. Dealers who honestly report the rates they use may have to reduce their transactions or avoid foreign currency deals altogether.

Uninformed interferences in discovering market-clearing rates tend to exacerbate excess demand.

Concerns about market manipulation by large aggregators lack substantial evidence.

While it's true that some players in global forex markets have engaged in collusion to manipulate spot FX rates and key benchmarks, there is scant documentation to indicate that large exchange houses in Bangladesh are involved in such practices.

Even if we assume they are, two critical questions arise. Firstly, why have they targeted Bangladesh specifically, and not Nepal or Sri Lanka, for example? Secondly, how does the opaque implementation of rate caps resolve this issue?

Could it not potentially lead to a solution that's more detrimental than the problem itself?

Instead, market participants are more concerned about the disruptive measures taken by BB to control the forex market, which ultimately dries up supplies.

Foreign exchange trades, much like water, will always find a way to flow through various channels, each with its own set of consequences.

It appears we are not heeding the lessons of history. Globally, some studies indicate that interventions can mitigate exchange rate volatility and help stabilise currencies, while others suggest minimal or no effect.

There is also evidence that central bank interventions can exacerbate exchange rate issues. When market participants view interventions as indicators of underlying economic troubles, they tend to speculate, hence fueling volatility wherever it can manifest, much like water finding its way.

A risk we can avert

The severe unintended consequences of rate cap induced volatilities often go unnoticed, except in remittances and pressure on banks' net open positions.

They encourage cat-and-mouse games between market participants and the BB.

Balancing surveillance with market freedom is tricky. Past well-meaning interventions led to negative outcomes, where foreign exchange shortages replaced depreciation as a persistent inflation driver.

A divergence between de jure (official) and de facto (actual) monetary policy is detrimental.

The inconsistency between stated and practiced policies undermines the central bank's credibility, causing market uncertainty and a loss of investor confidence.

Markets react to this divergence with heightened volatility, as investors and traders anticipate future policy moves.

If participants believe BB will not follow its stated policy, it invites speculative attacks on the currency, misaligned exchange rates, and distorted economic signals. Consistency and transparency in policies are crucial to avoid these issues.