Monetary policy is a crucial tool for managing a country's economy. It involves the regulation of money supply and interest rates by a central bank to achieve macroeconomic objectives such as controlling inflation, maintaining currency stability, and fostering economic growth. For a developing country like Bangladesh, an effective monetary policy is essential in steering economic stability and growth, especially during periods of global economic uncertainty.

In the context of the capital market, monetary policy plays a significant role. It influences the cost of borrowing, investment returns, and overall economic confidence. A well-crafted monetary policy can enhance investor confidence, promote stability in financial markets, and encourage investment. However, changes in interest rates and currency stability can directly impact capital market performance, affecting stock and bond valuations.

Bangladesh Bank's recent monetary policy statement for the first half of FY25 continues its contractionary stance, primarily targeting inflation control. The policy holds the repo rate steady at 8.5 percent, maintaining the policy rate corridor at 300 basis points, with the standing deposit facility at 7 percent and the standing lending facility at 10 percent. This approach underscores the central bank's commitment to containing inflation within 6.5 percent while aligning with the government's GDP growth target of 6.75 percent. Due to political turmoil and unrest, it is predicted that the forecasted GDP growth rate will decrease further, and the economy will stagnate in the long run.

As a capital market expert, I view this policy as a mixed bag for the market. On one hand, higher interest rates make borrowing more expensive, which can dampen corporate profits and reduce stock market activity. Investors often perceive high interest rates as a signal to shift from equities to fixed-income securities, like bonds, due to better returns. Consequently, this could lead to reduced demand for stocks, impacting overall market liquidity and investor sentiment.

The crawling peg exchange rate system introduced by Bangladesh Bank aims to stabilise the currency by linking it to a basket of currencies. While this move supports exchange rate stability, it might limit potential capital gains from foreign investment in the stock market due to reduced currency depreciation risks. This policy aims to control inflation but also places pressure on domestic companies reliant on imports, as input costs remain high due to a strong currency.

The emphasis on private sector credit growth, set at 9.8 percent, reflects the bank's cautious stance. This modest target may hinder the expansion plans of businesses, impacting sectors dependent on credit for growth. In such a scenario, companies with strong balance sheets might fare better, but overall corporate investment could slow, affecting stock market growth prospects.

For the bond market, the current monetary policy environment appears more favourable. Higher interest rates increase the appeal of bonds as they offer better returns compared to equities under such conditions. Investors seeking stable and predictable income streams might prefer bonds, resulting in a shift from equities to fixed-income securities. This trend could lead to increased bond issuance and trading activity, bolstering the bond market's prospects. However, the contractionary policy could pose challenges for new equity listings. Companies might defer initial public offerings (IPOs) due to unfavourable market conditions, impacting market dynamism. Additionally, existing companies might face increased borrowing costs, affecting their profitability and stock performance.

To mitigate these challenges and enhance capital market growth, Bangladesh Bank could consider adopting a more balanced approach. A gradual easing of interest rates might stimulate economic activity without undermining inflation control efforts. Furthermore, promoting initiatives to deepen the bond market and increase financial literacy can attract more investors, fostering a vibrant capital market.

While Bangladesh Bank's monetary policy for the first half of fiscal year 2024-25 prioritises inflation control and economic stability, its impact on the capital market presents both opportunities and challenges. By carefully balancing monetary measures and supporting market development, the central bank can better harness the capital market's potential to contribute to the country's economic growth and resilience.

The views expressed are personal. The author is a capital market analyst and can be reached at shahriar@unicap-securities.com