Monetary Policy of Bangladesh and Its Impact on Economy Essay

MONETARY POLICY OF BANGLADESH AND ITS IMPACT ON ECONOMY Monetary policy is concerned with the measures taken to control the supply of money, the cost and availability of credit. Further, it also deals with the distribution of credit between the uses and the users, the lending and borrowing rates of the banks. In a developing country like ours the monetary policy has been effectively used as a tool for overcoming depression and inflation. As Prof R. Prebisch writes “The time has come to formulate a monetary policy which meets the requirement of economic developments which fit in to its framework perfectly. Along with the economic growth the monetary policy has also to ensure price stability, as excessive inflation has an adverse distribution effect and hinders the economic development. To understand the monetary policy of Bangladesh it is important to understand the objectives or goals, targets and instruments of monetary policy. The goals refer to the objective which may be price stability or economic growth. Whereas the targets refer to the variables such as supply of money, bank credits and interest rates.

The instrument ate the changes in supply of currency, bank rates and other interest rates, open market operation, changes in reserve requirement, selective credit contras. PRESENT MONETARY POLICY OF BANGLADESH: The central bank of Bangladesh has actually followed a policy of restring growth rate of the economy. It is almost two years mow, that the central bank of Bangladesh has made a switch to a concretionary monetary policy. Bangladesh Bank is bit reluctant about admitting the term contractionary; it favours the term “causious”.

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It points out a reason, that there is no contruction in money or credit supply. It this policy, Bangladesh Bank raise the reserve requirement as a result the deposits of banks contracts and availability of credit reduces and cost of credit increase as the interest rate rises. IMPACT OF MONETARY POLICY IN OUR ECONOMY OBJECTIVES OF MONETARY POLICY ADOPTED BY BANGLADESH BANK: 1. Ensuring price stability or controlling inflation 2. Encouraging economic growth. 3. Ensuring exchange rate stability for taka. That the exchange rate of Tk.

With dollar, euro and other foreign currency. Let us explain the objectives below: a) PRICE STABILITY OR CONTROL OF INFLATION: Achieving price stability has remained the dominant objective of Bangladesh Bank. It may however be noted that price stability does not mean, there is absolutely no changes in price at all. In a developing country like ours where structural changes take places during the process of economic growth, some changes in the relative price do occur, that generally put upward pressure on price. Price stability means a reasonable rate of inflation.

The Bangladesh Bank expects to contain the rate of inflation between 6. 85% and 6. 95% in the current fiscal year 2006 and 2007 pursuing a cautious monetary policy. A high degree of inflation has adverse effects on the economy. A high inflation raises the cost of living. Therefore it is described ad the no. 1 enemy of poor. Inflation makes exports costlier and people are induced to import good. In contractionary monetary policy a rise in interest rate increase the cost of credit and reduce the money supply in the economy and thus control the inflation.

The main causes behind the high inflation in our country are draining out of money and artificial crisis create by some businessmen. Drain’ out occurs when any foreign country invest in our country and uses their own human and equipment resource. The gaining from the investment does not remain in our country and increase inflation. Artificial crisis is created as few businessmen stocks goods of inelastic demand and raises the price. b) ENSURING ECONOMIC GROWTH: Promoting economic growth is another important objective of monetary policy of Bangladesh.

In the past year Bangladesh Bank had been criticized that it pursued the objective of achieving price stability and neglected to objective of promoting economic growth. Monetary policies can promote economic growth by ensuring adequate availability of credit and lower cost of credit. Easy availability of credits at low interest rate stimulation investment and thereby quickens economic growth. The MPS of Bangladesh Bank says, “Monetary policies at the second half of the FY07 continue to aim it supporting annual real GDP of 7. percent, while keeping the inflationary pressure under control. ” According to Bangladesh Bank a tight monetary policy will provide the appropriate environment under which the growth can occur in the long run. But in the short run there exists tradeoff between growth and inflation. Higher economic growth gives rise to money supply which leads an increase in aggregate demand and cause inflation. A developing country like Bangladesh needs both control over inflation and a sustainable economic growth. Only by expanding the real scope of growth this objective can be achieved.

When money supply exceeds the out put the aggregate demand rises beyond the ability of economy. Only by increasing real scope govt. can increases aggregate demand effectively with our any side effect. The growth rates of currency in circulation and demand deposits indicate the extent of inflationary bias. In FY05, growth rates of credit to public and private sectors both exceeded program levels, showing excess demand and inflationary bias, which also showed up on the liability side in the high growth rates of currency in circulation and demand deposits.

These evidences of excess demand and inflationary pressure prompted the tightening of monetary policy stance for FY06. While contractionary monetary policy continued beyond FY 05 to mop-up monetary overhang, GDP growth rate for FY 06 is estimated at much higher rate of 6. 5 percent mainly reflecting better performance of agriculture sector supported by growing industrial and services sectors. The growth rate would even be higher depending on final outturn of the boro crop. c) EXCHANGE RATE STABILITY: Exchange rate, which is now market determined under floating exchange rate regime, faced some volatility.

After remaining stable for a long time, the taka-dollar rate depreciated by 8. 8 percent during the current fiscal year up to April 06. Considering the tight liquidity position ‘and noting that the real interest rate has fallen very low as the inflation rate has risen, banks are now compelled to offer higher nominal interest rate, or in other words, positive real rates to attract their deposits, without which credit expansion and rise in investment would not be possible. The banks would hopefully lower the nominal rates as soon as their liquidity position improves.

Similarly we will allow exchange rate to move with market fundamentals without volatility. The exchange rate policy of Bangladesh Bank aims at maintaining the competitiveness of Bangladesh product in the international market; encouraging the inflow of wage earner remittance, maintaining internal price stability. Previously the exchange rate of Bangladesh was fixed. But now the exchange rate of Tk is determined by the demand for and supply of foreign exchange, which indicate flexible exchange rate. To arrest the fall in the value of Tk.

Due to high inflation, Bangladesh Bank raise the C. R. R ratio to reduce the liquidity in Banking system. The higher cost of credit and lower availability of credit, borrowing from bank is discouraged which is expected to reduce the demand for dollars. Recent Referce Ex. Rate | |Buying |Selling | |US $/ BD tk. |68. 95 |69. 00 | |Euro |91. 15 |91. 23 | * TARGETS: i. CRR and SLR: In October 2005, the CRR and SLR were revised upward from 4. % and 16% to 5% and 18% with to view to slowing down overall domestic credit growth. ii. INTEREST RATE: The intent of Bangladesh Bank’s monetary policy is very clearly reflected in a range of interest rates such as the rates on treasury bills and government bonds of various maturities rates on bank advances. These rates have all risen steadily since March 2005. The 28-day Treasury bill rate has risen by 2. 62 per cent while the rate on bank advances has risen by 1. 67 per cent between March 2005 and September 2006.

These are very substantial increases in the interest rates and doubtless indicate a steady tightening of the money market. This policy-induced monetary contraction has no doubt helped in keeping a lead on the inflation rate, but it has also dampened business enthusiasm to invest. Tighten the money market Bangladesh Bank attempt to raise the interest rate. Interest rate is principal transmission channel of monetary policy. The intent of Bangladesh Bank monetary policy is clearly reflected in the increase in interest rate since December 2005 to January 2006 from 8. 1% to 14. 87%. Interest rates |Bank Rate |Borrowing Rate |Lending Rate |Deposit | |5. 00 |14. 87 |14. 87 |5. 9 | IMPACT ON INTERNATIONAL TRADE: The tight monetary policy depressed import growth to 10% during the first nine months of the fiscal year, as reduction in inflation makes the domestic good cheaper. But high interest rate dampened the business enthusiasm to invest.

Due to the lack of domestic investment, domestic goods become expensive, and boost the import and reduce export. Import & Export: The tight money depressed import growth to 10 percent during the first nine months of the fiscal year. Nevertheless, imports for capital machinery rose by 25 percent ensuring continued investments. Despite difficulties in the garment sector following MFA Phase out, 31 percent growth in knitwear contributed to about 19 percent increase in exports. A growth rate of 23 percent in inward remittances provided a cushion for the external sector.

Foreign exchange reserve position stood at about $ 3 billion on 15 May 2006, which is equivalent to 2. 5 months of imports. The effects of monetary contraction have been now further accentuated by the unfavorable circumstances of the last several months. Although the Bangladesh Bank governor has boldly predicted a growth rate of 7 percent or higher for the fiscal year 2006-07, it is doubtful that the economy can maintain the growth momentum already achieved. The latest indications regarding the volume of exports, imports, and investment are not very encouraging.

Unless the government takes some urgent measures to improve the situation we shall have a rather ordinary year ahead. This will make poverty alleviation that much harder to achieve; many poor people will have to wait longer for a remission of their misfortune. Monetary policies aimed at supporting real annual GDP growth of seven percent will continue unchanged in the cautious and restrained stance in H2 FY 07 keeping in view the prevailing external situation and the internal risks to price stability posed by the domestic situation mentioned in the foregoing paragraphs.

The policy stance will of course be adapted promptly and flexibly in the face of any unfolding development, with special attention to the credit needs of sectors promoting and supporting economic growth. BIBILIOGRAPHY 1. The Daily Star 2. www. bangladeshbank. org. bd ———————– Government Monetary Policy Relative Inflation Rate Relative Interest Rate Relative National Income Level Exchange Rate International Capital Flows International Trade Government Intervention in Foreight Exchange Market Government Purchase & Sell Securities Quotas, Tariff Tax Laws


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