Increasing Interest Rates : Can Control Inflation in Bangladesh?

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Increasing Interest Rates: Can Control Inflation
in Bangladesh?


Increasing Interest Rates

Introduction:

Bangladesh Bank has recently been pursuing a strategy of
raising interest rates on loans as a means to combat inflation. Over the past
four months, the maximum interest rate on loans has been increased from 9% to
11.93%. While this move seems to be a step towards addressing inflation, a
closer examination of Bangladesh’s economic history reveals that there is no
straightforward correlation between interest rate adjustments and inflation
control.

To put this in perspective, let’s take a journey back to the
1980s when the commercial bank interest rates for loans were in the range of
18-20%. At that time, the nation was grappling with inflation rates in the
double digits. Surprisingly, in 2020, when the maximum interest rate on loans
was raised to 9%, the inflation rate dropped below 6%. This discrepancy
suggests that high interest rates on loans in the past did not necessarily
translate into effective inflation control for Bangladesh.

Economists point out that around 50% of the country’s economy
remains beyond the control of banks. This lack of oversight hampers the
government’s ability to regulate the market effectively. In Bangladesh, the
consumer goods market is largely dominated by syndicates. A handful of
influential business owners can easily manipulate prices through cartel
activities, and corruption and the prevalence of black money further complicate
the situation. Thus, solely increasing interest rates on loans may not be the
silver bullet for controlling inflation. Instead, it requires a
well-coordinated effort from various stakeholders.

Anis A. Khan, a seasoned banker who embarked on his banking
career in 1982, provides valuable insights based on his experience. He
reflects, “In the 1982-83 fiscal year, I collected deposits at interest
rates ranging from 14-16% in ANZ Grindlays Bank. During that time, I lent money
at interest rates even higher than the cost of funds in mutual trust banks.
Interest rate adjustments for other accounts, including savings accounts, were
around 17-18%. Government and private banks in the country also had interest
rates higher than this. In those days, the inflation rate was well above
12%.”

Khan emphasizes that “Based on my extensive experience,
I can confidently say that the market situation in Bangladesh is not solely
dependent on the interest rates on bank loans. Syndicates, cartel activities,
and black money have created a situation where the market conditions in
Bangladesh cannot be influenced by mere interest rate adjustments. Only
increasing interest rates on loans will not be enough to lower commodity
prices. Therefore, a combined effort from all parties is needed to regulate the
market. In addition, as the dollar strengthens, there is a risk that global oil
prices will rise in the future, leading to further inflation in the
country.”

To delve deeper into the historical context, in the 1984-85
fiscal year, the average interest rate adjustment on loans in the country was
14.5%, while the average inflation rate was 10.9%. Remarkably, data from the Bangladesh
Bureau of Statistics for the same year shows an average inflation rate of
10.9%. This suggests that although banks had high interest rates on loans,
these rates did not have a direct impact on inflation control.

Continuing into the 1990s, the average interest rate
adjustment on loans increased to 14.8%, but inflation rates dropped to 8.9%. In
1995, the average interest rate on loans was raised to 13.8%, yet inflation
only increased slightly to 8.9%. These observations underscore that economic theories
and interest rate adjustments have not been consistent i controlling inflation
in Bangladesh over the past four decades.

It is clear that merely increasing interest
rates on loans may not be the most effective strategy to control inflation in
Bangladesh. The complex economic landscape of the country, characterized by
syndicates, cartel activities, and a significant portion of the economy
operating outside the banking system, requires a more comprehensive approach.
Cooperation between government agencies and financial institutions is crucial
to maintain price stability in the face of inflationary pressures. As
Bangladesh navigates the challenges of its evolving economy, a multi-faceted
strategy will be essential to strike the right balance between economic growth
and inflation control.

Over the past decade, Bangladesh has witnessed a peculiar
trend in its economic landscape, where the character of inflation seems to
follow a parallel path to that of interest rates. This phenomenon has raised
concerns among policymakers, economists, and the general public. In the
following discussion, we will delve deeper into the changing dynamics of
inflation and interest rates in Bangladesh, the challenges posed by this
unusual correlation, and potential solutions.

The Historical Perspective:

The historical perspective on Bangladesh’s economic indicators provides a compelling backdrop to understand the intricate relationship between bank loan interest rates and inflation. In the 2014-15 fiscal year, the country witnessed an average bank loan interest rate of 11.7%, while the inflation rate stood at a relatively moderate 6.4%. This period marked the beginning of a trend that challenges conventional economic wisdom.

Fast forward to the 2019-20 fiscal year, and a noteworthy shift occurred. Despite a significant reduction in the average bank loan interest rate to 7.9%, the inflation rate remained relatively steady at 5.6%. This apparent divergence between interest rates and inflation challenges the conventional understanding that higher interest rates should lead to lower inflation. This anomaly prompts a critical examination of the multifaceted factors influencing Bangladesh’s economic dynamics.

The most recent data from the 2022-23 fiscal year adds another layer to this evolving narrative. The average bank loan interest rate further decreased to 7.1%, yet inflation surged to an alarming 9.0%, surpassing the previous years. This unexpected divergence raises questions about the effectiveness of relying solely on interest rate adjustments as a tool for inflation control.

Dr. Mustafa Kamal, a former Chief Economist of the Bangladesh Bank, provides valuable insights into this complex scenario. He emphasizes that the unique economic landscape of Bangladesh demands more comprehensive measures beyond interest rate adjustments alone. The multifaceted nature of inflation in the country, influenced by factors such as supply chain disruptions, global economic conditions, and the presence of syndicates and cartels, requires a nuanced approach.

The divergence between interest rates and inflation in Bangladesh challenges traditional economic theories that posit a direct and inverse relationship between these two variables. Dr. Kamal’s stance underscores the need for a deeper understanding of the specific economic nuances at play in Bangladesh. It suggests that addressing inflation in this context goes beyond the scope of interest rate adjustments and necessitates a more holistic strategy.

In conclusion, the historical perspective on bank loan interest rates and inflation in Bangladesh unveils a complex narrative that defies conventional expectations. The observed divergences emphasize the importance of considering a broader set of economic factors when formulating policies for inflation control. As Bangladesh grapples with the challenges of its evolving economic landscape, Dr. Kamal’s insights underscore the need for policymakers to adopt a more comprehensive and nuanced approach to effectively manage inflation in this unique context.

Understanding the Complex Nature of Inflation:

The complex nature of inflation in Bangladesh is underscored by a set of distinctive economic dynamics that differentiates it from the mechanisms observed in more advanced economies. In many developed nations, the relationship between interest rates and inflation is relatively straightforward: raising interest rates tends to influence consumer behavior by increasing borrowing costs, subsequently leading to reduced spending and investment, which, in turn, can exert downward pressure on inflation.

However, Bangladesh’s economic environment presents a unique set of challenges. Dr. Bonik Bartha, the former Managing Director of the Bangladesh Institute of Development Studies (BIDS), sheds light on these intricacies. The distinctive nature of managing inflation in Bangladesh is attributed to several factors that distinguish it from more developed nations. In developed countries, government agencies often wield substantial regulatory power, and market conditions are typically characterized by greater stability. Consequently, manipulating the prices of essential commodities in these economies is not as straightforward, as stringent regulations and market forces act as checks against abrupt price fluctuations.

In contrast, Bangladesh faces a more intricate challenge due to its susceptibility to sudden disruptions in supply chains. The supply of specific commodities, essential for everyday life, can decrease abruptly due to factors such as transportation issues, natural disasters, or geopolitical events. This vulnerability to supply chain disruptions creates an environment where price manipulation can occur more easily. When the supply of crucial goods diminishes unexpectedly, market forces can drive rapid and unforeseen price hikes.

The implication of these factors is that the efficacy of controlling inflation through mere adjustments in interest rates becomes limited in Bangladesh. Unlike in more developed economies where interest rate adjustments are often sufficient to influence consumer behavior and manage inflation, the multifaceted nature of the Bangladeshi economic landscape demands a more nuanced approach.

In summary, understanding the complex nature of inflation in Bangladesh requires recognizing the influence of a multitude of factors, including the vulnerability to supply chain disruptions and the ease with which price manipulation can occur. Dr. Bonik Bartha’s insights highlight that conventional monetary tools, such as adjusting interest rates, may not be as effective in this context. Policymakers in Bangladesh must consider these unique challenges and tailor their strategies to address the specific economic nuances of the country, incorporating measures that go beyond traditional interest rate adjustments to effectively manage inflation.

The Recent Inflation Surge:

The recent surge in inflation, reaching its peak at 9.63% in September, has indeed raised significant alarms, sparking concerns about the cost of living for citizens and the overall economic stability of Bangladesh. Despite a slight decrease from this peak, the inflation rate stubbornly remains high, hovering around 9%. This rapid and sustained inflation has far-reaching implications, necessitating a comprehensive response that takes into account the unique economic landscape of Bangladesh.

The impact of such high inflation is keenly felt by citizens, with profound consequences for their purchasing power and overall standards of living. As inflation erodes the value of money, consumers find themselves grappling with higher prices for goods and services. This erosion is particularly detrimental for those with fixed incomes, such as retirees and individuals on fixed salary structures. The real income of citizens is effectively diminished, leading to a decline in their standards of living

The rising cost of essential goods and services further exacerbates the challenges faced by households. Basic necessities, including food, fuel, and housing, become more expensive, placing an increased financial burden on families. This financial strain can result in families making difficult choices, potentially sacrificing discretionary spending or cutting back on non-essential expenses to cope with the higher costs of living.

Moreover, high inflation rates can have broader implications for social and economic stability. The burden on households can lead to social challenges as families navigate the impact on their day-to-day lives. The overall economic stability of the country may also be at risk, as businesses and investors face uncertainties amid rising costs.

Addressing this issue comprehensively is imperative, considering the unique economic landscape of Bangladesh. Policymakers must formulate strategies that not only focus on short-term fixes but also address the root causes of inflation. While interest rate adjustments, as seen in the policy response, play a role in managing inflation, a holistic approach involves tackling issues such as supply chain disruptions, market dynamics, and global economic factors.

Collaboration between government agencies, financial institutions, and other stakeholders is crucial to crafting policies that are well-suited to Bangladesh’s specific economic context. This collaborative effort should extend to regulatory measures to curb the influence of syndicates and cartels, fostering financial inclusion to bring informal economic activities into the formal banking sector, and implementing fiscal policies that address structural issues within the economy.

As Bangladesh grapples with the challenges of the recent inflation surge, a proactive and coordinated response will be essential to mitigate the immediate impacts on citizens and pave the way for sustained economic stability and growth in the longer term.

Policy Response: Interest Rate Adjustments:

The policy response by the Bangladesh Bank to address the surging inflation reflects a proactive stance aimed at managing the economic challenges posed by rising prices. The measures taken, primarily focused on interest rate adjustments, demonstrate a commitment to stabilizing the economy and curbing inflationary pressures. The key components of this policy response include changes to the policy interest rate (repo rate), the Standing Lending Facility (SLF) rate, and the Standing Deposit Facility (SDF) rate.

Firstly, the policy interest rate, commonly known as the repo rate, experienced a substantial increase of 75 basis points, reaching a new level of 7.25%. This adjustment serves as a clear signal of the central bank’s intent to tighten monetary policy. By raising the repo rate, the central bank aims to make borrowing more expensive for financial institutions, influencing their lending behavior. This, in turn, is expected to have a cascading effect on overall borrowing costs in the economy, leading to reduced spending and investment.

Simultaneously, the SLF rate for banks from the central bank was revised upwards from 8.50% to 9.25%. The SLF rate represents the interest rate at which banks can borrow funds directly from the central bank. An increase in this rate is designed to make borrowing from the central bank more costly for commercial banks. This move aims to discourage banks from relying heavily on central bank funds, which, in turn, helps reduce excess liquidity in the market.

Additionally, the SDF rate for banks has been raised from 4.50% to 5.25%. The SDF rate pertains to the interest rate at which banks can park their surplus funds with the central bank. By elevating this rate, the central bank encourages banks to deposit more funds with itself rather than circulating excess liquidity in the market. This action is aimed at managing liquidity levels effectively, preventing an influx of money that could contribute to inflation.

In essence, these interest rate hikes collectively aim to “mop up” excess liquidity from the market. Excessive liquidity, often resulting from increased borrowing and spending, can contribute to inflationary pressures by driving up demand for goods and services. The Bangladesh Bank’s strategy involves strategically adjusting interest rates to influence borrowing behavior, liquidity levels, and, ultimately, inflation.

It’s crucial to note, however, that while interest rate adjustments are a vital tool in managing inflation, they represent only one facet of a comprehensive strategy. The multifaceted nature of inflation in Bangladesh, as discussed earlier, requires a holistic approach that also addresses supply chain disruptions, market stability, and collaboration between government agencies and financial institutions. Achieving a balance between these elements will be instrumental in effectively managing inflation amid the unique challenges faced by Bangladesh’s economy.

A Holistic Approach:

While these measures may have some impact on curbing
inflation, the complex nature of the situation in Bangladesh suggests that a
multi-pronged approach is required. Addressing inflation in Bangladesh should
not be limited to interest rate adjustments alone. It should also encompass
efforts to manage supply chain disruptions, enhance market stability, and
foster close collaboration between the central bank and the government.

Balancing economic growth with inflation control remains a
formidable challenge for Bangladesh. The unusual correlation between inflation
and interest rates demands a holistic strategy, acknowledging the uniqueness of
the nation’s economic landscape. To effectively tackle the issue of rising
inflation, Bangladesh must rely on a collaborative approach that combines
interest rate adjustments with proactive policies aimed at enhancing market
stability and addressing supply chain disruptions. This multifaceted strategy
will be essential to ensure a stable and prosperous economic future for the
country and its people.

Bangladesh’s economic landscape has experienced a remarkable
conundrum over the last decade, where both inflation and interest rates have
shown a peculiar pattern of growth. In the 2014-15 fiscal year, the average
bank loan interest rate was reported at 11.7%, while the inflation rate was
relatively modest at 6.4%. This period marked the beginning of a trend that has
left many economists and policymakers scratching their heads. Traditionally, in
most economies, including developing ones, there exists an inverse relationship
between interest rates and inflation. As interest rates rise, consumer spending
and borrowing decrease, which, in turn, reduces overall demand and inflation.
However, in Bangladesh, this relationship has been more complex, as the country
has witnessed a sustained period where interest rates increased significantly
without having a substantial impact on inflation.

In contrast, the latest data for the 2022-23 fiscal year
paints a different picture. Bangladesh has experienced a significant surge in
inflation, with rates reaching a staggering 9.0%. This sharp increase has
raised critical questions about the effectiveness of using interest rates as a
tool to control inflation in the country. It has also left economists pondering
the intricate dynamics of Bangladesh’s economy. In this context, it’s crucial
to explore the factors contributing to this phenomenon and why traditional
monetary policy tools, like adjusting interest rates, may not be sufficient to
manage inflation effectively in this unique economic environment.

The unique economic correlation between inflation and
interest rates in Bangladesh can be attributed to the multifaceted nature of
inflation in this developing nation. Unlike more developed economies, where
inflation is often driven by broader macroeconomic factors, Bangladesh’s
inflation dynamics are influenced by a myriad of local and global variables.
Various factors, such as supply chain disruptions, sudden changes in commodity
prices, and shifts in global economic conditions, can lead to rapid
fluctuations in consumer prices. These volatile variables are beyond the
control of traditional monetary policy tools, like adjusting interest rates.

One primary reason for Bangladesh’s complex inflation
landscape is its reliance on imports for many essential goods and raw
materials. Fluctuations in global commodity prices, currency exchange rates,
and disruptions in the global supply chain can quickly impact local prices. For
instance, a spike in international oil prices or supply chain disruptions can
lead to higher prices for fuel and essential goods in Bangladesh. Therefore,
the country requires a more comprehensive approach to tackling inflation that
goes beyond adjusting interest rates. Policymakers must consider measures to
stabilize supply chains, manage market conditions, and collaborate closely with
other stakeholders to address the root causes of inflation.

 In response to this inflation surge, the Bangladesh Bank has
taken steps to address the issue. They raised policy interest rates and other
key rates in an attempt to curb inflation. While these measures may help
contain inflation to some extent, it’s increasingly evident that managing
inflation in Bangladesh requires a more holistic and multifaceted strategy.
This strategy should not only rely on interest rate adjustments but should also
focus on managing supply chain disruptions, enhancing market stability, and
fostering close collaboration between the central bank and the government to
ensure a stable and prosperous economic future for Bangladesh. A comprehensive
approach, tailored to the unique economic conditions of the country, is
essential to navigate the challenges posed by inflation and interest rate
dynamics in Bangladesh.

The issue of inflation control in Bangladesh
is not a solitary challenge; rather, it’s a multifaceted puzzle that
necessitates a comprehensive strategy. Bangladesh’s economy features a
significant informal sector, which often operates outside the conventional
banking system. The presence of these unregulated economic activities
contributes to the complexity of the country’s inflationary environment.
Moreover, the activities of syndicates and cartels, which often manipulate
prices and create artificial shortages, pose a significant obstacle to
traditional monetary policy tools.

Conclusion:

To effectively manage inflation, Bangladesh needs to pursue
a multi-pronged approach. This includes strengthening regulatory measures to
curb the influence of syndicates and cartels, fostering financial inclusion to
bring informal economic activities into the formal banking sector, and
implementing fiscal policies that address the structural issues within the
economy. Moreover, it’s essential for government agencies and financial
institutions to work in tandem, sharing data and insights to make informed
decisions about inflation control. Collaboration between these stakeholders
will be instrumental in crafting policies that are well-suited to Bangladesh’s
unique economic landscape.

As the nation moves forward, balancing economic growth with
inflation control remains a priority. It’s clear that a mere reliance on
interest rate adjustments won’t suffice. The path to a stable and prosperous
economic future for Bangladesh lies in its ability to adapt and evolve,
leveraging a multifaceted strategy that addresses the multifaceted nature of
inflation in the country. By doing so, Bangladesh can secure its place as a
growing and resilient economy that effectively manages inflation while
fostering sustainable growth.

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