Three tough choices to heal the economy

Bangladesh took three key decisions yesterday to shore up the economy against key risks such as stubborn inflation and dwindling foreign exchange reserves.

In a rare move, the central bank devalued the local currency by Tk 7 to Tk 117, a steep one-day decline against the powerful dollar. What’s more, it has loosened its old grip on Dhaka as it will now follow the crawling peg, a flexible exchange rate system.

Abandoning the treasury bill-linked formula for banks, Bangladesh Bank has made lending rates entirely market-based. This marks a major shift from the command and control mechanism imposed on banks four years ago.

The monetary authority raised the overnight repurchase agreement rate, the short-term borrowing cost for banks, by 50 basis points to 8.5 percent, the second consecutive hike this year.

All three decisions coincided with the International Monetary Fund’s pledge to provide a $1.15 billion loan to Bangladesh. The measures reflect the authorities’ struggle to get the economy back on track.

According to BB’s Monetary Policy Committee, the economy faced two critical challenges — persistently high inflation and dwindling foreign exchange reserves.

Despite various measures taken by BP and the government to control inflation, stabilize the exchange rate and protect foreign exchange reserve erosion, inflation remained stubbornly high and the foreign exchange reserve situation did not improve as desired, the central bank said.

Inflation has hovered above 9 percent since March last year, and the local currency has weakened 35 percent against the U.S. dollar in the past two years. The country’s reserves have halved, bringing one of the worst economic crises to the lower-middle-income country. It has struggled to raise enough taxes to cover its growing spending.

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The central bank’s results came as the IMF team led by Chris Papageorgiou wrapped up a 15-day visit to Bangladesh yesterday. During the visit, discussed the economic and financial policies in the context of the second review of the debt program.

In a statement, Chris Papageorgiou described BB’s actions as bold, aimed at rebalancing the exchange rate and simultaneously adopting a creeping peg regime.

Speaking to The Daily Star, Mutual Trust Bank Managing Director Syed Mahbubur Rahman welcomed the scrapping of the smart formula. „Now, the interest rate will be market dependent,” he said.

As the policy rate has been revised upwards and the reference lending rate known as SMART has been scrapped, the interest rate may rise. That would make funds more expensive, which would help curb central bank demand, but would also be a blow to borrowers.

Similarly, an increase in the exchange rate could come as a boon to exporters and remitters as they would get a better US dollar rate, whereas importers would have to pay more to buy goods and inputs from the world market.

„A flexible exchange rate is necessary for us as the cost of doing business has gone up significantly due to increasing gas and electricity charges. The government has also reduced cash incentives for export receipts,” said SM Mannan Kochi, Chairman, Bangladesh Garments Manufacturers. Exporters Association.

Dhaka Chamber of Commerce and Industry President Ashraf Ahmed said the move towards a market-based exchange rate is a step in the right direction.

Subir Kumar Ghose, chief executive officer of Partex Petro Ltd, has predicted that interest rates in the banking sector could go up to 20 per cent.

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The average loan ratio was less than 14 percent yesterday.

Humayun Rashid, managing director of Energypack Power Generation, said interest rates would rise immediately as banks charge higher rates for deposits.

Bangladesh Bankers Association President Selim RF Hussain feels that a flexible interest rate and exchange rate will help reduce capital flight from Bangladesh.

Ahsan H Mansoor, managing director of the Institute for Policy Research, said a rise in interest rates could further dampen the economy. „But challenges are necessary to overcome.”

He said the introduction of the crawling peg would stabilize the Taka-Dollar exchange rate and improve foreign exchange reserves.

„Daka may depreciate further,” he said, urging the government to end the remittance subsidy.

Asked whether these measures would bring stability back to the economy, the former IMF economist said, „These are necessary measures, but not sufficient. However, without these measures, the economy cannot help overcome the crisis.”

Speaking at the Finance Ministry’s media briefing, Chris Papageorgiou said reserves are falling due to a real confluence of external shocks such as the Ukraine war, rising interest rates and commodity prices worldwide.

Higher prices have deflated the economy faster than other economies, pushing inflation to the highest level in a decade, he said.

The authorities took a bold step – a set of real reforms to deal with the current situation, he noted.

Papageorgiou said the introduction of a new flexible exchange rate and the abolition of SMART will help create more flexibility.

The IMF official said that for decades, the country’s tax-to-GDP ratio has hovered around 10 percent, one of the lowest in the world. „We think there’s room for improvement.”

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The IMF said prioritizing sustainable revenue generation is essential to increase investments in social welfare and development initiatives.

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