“Unless BB controls discretionary forces, no monetary policy will bring the expected results”

In a working paper recently published by the Asian Development Bank (ADB) entitled “Bangladesh Monetary Policy Transmission Mechanism”, the authors – In Huh and Yoonsoo Lee – found that the traditional monetary policy tools used by the Bangladesh Bank (BB), such as the repo rate and the reserve currency (RM), are not working as expected.

However, the National Savings Bond affects the economy in a manner more akin to that of a monetary tool.

Specifically, a positive shock to the reserve currency should lower the interest rate. In practice, however, as the article shows, a positive shock (BB’s expansionary policy) leads to an increase in the interest rate.

Also, increasing the repo rate (the rate at which banks borrow from Bangladesh Bank) is an example of tight monetary policy because it reduces the money supply and allows the central bank to control inflation under ideal circumstances. But the authors found that shocks to the repo rate had no significant impact on the broad money supply.

To explain these contradictory and counterintuitive results, the study argued that extremely high yield National Savings Certificates (NSCs) crowded out private sector investment and may have distorted the relationship between monetary instruments and their targets. .

The commercial standard spoke to Dr. Saleh Uddin Ahmed, former Governor of Bangladesh Bank, to make sense of the rather baffling findings of the AfDB Working Paper and asked for advice for the days ahead.

TBS: According to the AfDB report, the Bangladesh Bank’s monetary policies are not having the desired effect. Is it true ? Why does this happen?

Doctor Saleh Uddin: This is not entirely wrong. First of all, you have to understand that there is always a lag between the implementation of monetary policies and their impact. Monetary policy changes such as interest rate adjustment, Cash Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR) may take longer than usual to show the desired results.

More often than not, Bangladesh Bank fails to achieve the monetary policy goals it has set for itself. Changes in policy rates often do not have a significant impact on financial markets because they are not sufficiently sensitive to interest rates. This happens because the vast monetary reserve of Bangladesh comprises only 40% of all financial transactions. This is why even a change in interest rates as large as 1-2% may not affect the economy in the way BB predicts.

Moreover, monetary policy is always less effective than fiscal policy. I once argued that BB should stop focusing on policy rates and should instead focus on the proper implementation of its regulations and the compliance of private financial institutions with those regulations. Unless the private banks comply with the policies introduced by BB, the policies will never have the intended effect.

TBS: The AfDB study also asserts that the growing dependence on National Savings Certificates distorts the effects of monetary instruments? Is it true? How to solve this problem ?

Doctor Saleh Uddin: National savings certificates are high-yielding because the interest rates are much higher than bank rates. But those who buy NSCs are generally not big investors. At best, they can buy for 30 lakh Tk from NSC. Large investors do not invest through NSCs.

So, ideally, NSCs primarily serve as a government fiscal policy tool to provide a sort of safety net for the middle class, as well as the marginalized, instead of acting as a capital investment instrument.

However, this does not mean that its impact on monetary policy is insignificant. But I think it is not enough to distort the effects of monetary policy. There is a more systemic issue at play here which involves corruption, mismanagement and discretionary powers.

TBS: The AfDB study recommends that the development of a robust bond market would improve the market for loanable funds. How do you rate these recommendations?

Doctor Saleh Uddin: The development of a bond market is, without a doubt, essential for a more responsible investment environment. Globally, most investments are made either in the capital market or in the bond markets. Banks generally have an upper exposure limit beyond which they cannot and should not lend to protect public money from undue risk exposure.

But in the absence of a robust bond market and an underdeveloped stock market in Bangladesh, private banks lend beyond their exposure limits, leading to the crisis in which Bangladesh finds itself. currently our financial sector.

In addition to the development of a bond market, borrowing needs should be linked to equity held in the form of bonds, particularly in the case of large investments. In other words, one cannot contract a certain amount of loans without holding a threshold of equity. Simultaneously, Bangladesh Bank must also improve its aural prowess and financial management of the banking sector. A robust bond market, along with a well-managed capital market, has the potential to establish accountability in the loanable funds market.

TBS: The AfDB study also recommended that Bangladesh Bank pursue an interest rate-centric monetary policy, instead of the typical supply-centric instruments. What would be your recommendation?

Doctor Saleh Uddin: First, the Bangladesh Bank needs to ensure that the financial system, as well as the money market, is formalized. Most financial transactions currently take place informally. People take out loans from local loan sharks, pawnbrokers, relatives or friends instead of going to the formal money market. This is why monetary instruments appear inefficient.

The introduction of interest rate-centric instruments would also have a similar result unless the vast majority of financial transactions take place in the formal money market. And to ensure this, Bangladesh Bank must ensure financial inclusiveness to bring people into the formal money market. While mobile financial services have made progress in engaging marginalized rural communities, banks still have a long way to go.

TBS: What would be your general recommendation to the Bangladesh Bank to improve the effectiveness of its monetary policy?

Doctor Saleh Uddin: In short, Bangladesh Bank should not blindly follow the conventional monetary policy instruments followed in the UK or the US. Bangladesh Bank must first assess how its policy rates affect different sections of society differently. For example, how the same policy rates can affect large and small investors differently. Based on its assessment, it can set up blended policy rates, such as different interest rates for investors with different levels of capital.

More importantly, it is high time for the central bank to put an end to corruption and discretion. There is a discourse about “rules versus discretion”. Unless you follow the rules, discretion becomes the norm and most financial transactions in Bangladesh are executed by discretion. Unless BB addresses these discretionary forces, no monetary instrument will be able to deliver the desired results.

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