Inflation and the Liquidity Crisis in the Banking Sector

Inflation and the Liquidity Crisis in the Banking
Sector

Bangladesh Bank took measures to control inflation by
adjusting the policy rates and interest rates. However, despite these efforts,
inflation remains uncontrolled, and prices of essential commodities like onions
and potatoes continue to rise. 

The central bank increased the policy rate, also known as
the repo rate, to 7.25% at the beginning of the month. Simultaneously, they
raised the interest rate on bank loans by 5%. While these decisions were aimed
at curbing inflation, they haven’t had the desired impact. Onions, potatoes,
and many other daily necessities have seen a significant increase in prices.

In addition to raising interest rates, the central bank also
attempted to control the demand for money in the currency market.
Unfortunately, this initiative has not yielded the expected results. Many
private banks have now announced their intention to collect deposits with an
interest rate of 12-13%. Despite the interest rate hike, the liquidity crisis
in the country’s currency market has worsened.

As per Dr. Salehuddin Ahmed, former governor of Bangladesh
Bank, following conventional monetary policies to control inflation in
Bangladesh is challenging. He mentioned, “In Western countries, including
the United States and the United Kingdom, market-driven policies, including
interest rate adjustments, play a dominant role in economic management.
However, in our country, almost everything is regulated. More than 60% of the
banks in our economy are state-owned.”

Dr. Salehuddin Ahmed further explained, “Increasing
interest rates is not the only solution. The initiatives taken by Bangladesh
Bank to control the flow of money in the market, especially in SME,
agriculture, and production-related sectors, will have a detrimental impact on
these industries. Banks that are borrowing heavily from central banks won’t be
affected by monetary policy. It’s the supply chain of goods that needs
attention, particularly in production-oriented sectors, to ensure a stable flow
of money. Production-oriented sectors need incentives to ensure the smooth flow
of funds. Otherwise, the measures taken by Bangladesh Bank may exacerbate
inflation.”

The recent surge in high inflation compelled Bangladesh Bank
to make an immediate hike in the repo rate, taking it to 7.25%. Moreover, the
central bank raised the standing lending facility (SLF) rate from 8.50% to
9.25%. Simultaneously, the standing deposit facility (SDF) rate was adjusted
from 4.50% to 5.25%. As a result, banks in the country now have to pay higher
interest rates for their borrowings from the central bank.

Although Bangladesh Bank aimed to control inflation by
increasing interest rates and trying to limit the flow of money into the
economy, the situation in the currency market is quite challenging.
High-interest rates have not discouraged banks from accumulating money from
their customers. The daily cash amount banks were allowed to hold in their
accounts with the central bank was previously capped at 10,000 crores taka.
However, after the increase in interest rates, the amount of money held by
banks has gradually increased.

On October 25th, the banks had a record 24,455 crore taka in
their accounts with Bangladesh Bank. Moreover, even on the following day, banks
held more than 18,000 crore taka. In these cases, interest rates ranged from
7.25% to 9.25%. However, despite these measures, the liquidity crisis in the
country’s currency market has not been resolved.

Syed Mahbubur Rahman, the Managing Director of Mutual Trust
Bank, believes that the country’s currency market is currently in disarray. He
states, “Bangladesh Bank has taken measures to reduce people’s demand for
money. As a result, the banks are now carrying more liquidity. The higher rates
of return on government treasuries and bonds have led to a surge in investments
from commercial banks. This has increased the money supply in the market.”

In addition to state-owned banks, several private banks have
also decided to collect deposits at an interest rate of 9-10%. However, these
measures have not been successful in controlling the liquidity crisis. Due to
this, the price of government treasury bills and bonds has seen a significant
increase. Commercial banks, which have been borrowing from the central bank,
are now showing more enthusiasm for lending to the government.

A significant portion of the general public doesn’t have
savings due to high inflation. Banks, therefore, are experiencing slower
deposit growth. Moreover, due to the increase in interest rates, people are
unable to repay their loans, leading to a surge in default loans. This
situation is weakening the financial capacity of the banks.

In summary, Bangladesh Bank’s efforts to control inflation
and liquidity in the banking sector through interest rate adjustments and
limiting the demand for money have not yielded the desired results. The
liquidity crisis persists, and inflation continues to impact essential
commodities. It is evident that conventional monetary policies are challenging
to implement in a highly regulated economy like Bangladesh, and a broader
approach may be needed to address these economic challenges.

 On October 4th, Bangladesh Bank, the country’s central bank,
made a significant move by raising the policy rate or repo rate by a
substantial 75 basis points, taking it to 7.25%. In conjunction with this
decision, the central bank also increased the upper limit of the standing
lending facility (SLF) rate, which is the rate at which banks can borrow from
the central bank, from 8.50% to 9.25%. Furthermore, the lower limit of the
standing deposit facility (SDF) rate, the rate at which banks can park their
surplus funds with the central bank, was raised from 4.50% to 5.25%. These
changes have far-reaching implications for the country’s financial sector.

Increased Repo Rate :

The recent adjustment in Bangladesh’s repo rate, bringing it up to 7.25%, signifies the central bank’s concerted effort to rein in inflation. Despite this proactive move, the response from both the banking sector and experts has been mixed. While the central bank’s objective was to put a check on inflation through this interest rate hike, the harsh reality persists – essential commodities, such as onions and potatoes, continue to witness a surge in prices, indicating the lingering challenges in taming inflationary pressures.

The decision to raise the interest rate on loans is not without its repercussions, potentially impacting various sectors of the economy, with a particular spotlight on small and medium-sized enterprises (SMEs) and agriculture. Dr. Salehuddin Ahmed, a respected figure and former governor of Bangladesh Bank, has drawn attention to the complexities of employing conventional monetary policies in an economy where over 60% of banks are state-owned. In his view, a more encompassing strategy is imperative, one that not only addresses inflation but also delves into the intricacies of supply chain management and introduces incentives for production-oriented sectors. This approach, he contends, could offer a more comprehensive solution to stabilize economic conditions.

The disparity between the central bank’s actions and the persistent rise in prices of essential commodities suggests that the inflationary challenge requires a nuanced approach. While the repo rate hike is a tool in the arsenal of monetary policy, its efficacy seems limited in the face of broader economic intricacies. The unintended consequences, particularly on SMEs and agriculture, underscore the need for a holistic strategy that goes beyond interest rate adjustments.

As Bangladesh grapples with the ongoing inflationary pressures, stakeholders in the economy may need to reconsider the conventional playbook. Dr. Salehuddin Ahmed’s insights shed light on the structural nuances of the Bangladeshi economy, emphasizing the importance of addressing the root causes rather than relying solely on interest rate manoeuvres. The road ahead may involve collaborative efforts, involving policymakers, financial institutions, and industry players, to formulate a multifaceted approach that ensures stability across sectors and fosters sustainable economic growth.

Impact on Liquidity :

The fundamental objective behind Bangladesh Bank’s policy rate hike was to strategically curtail the supply of money in the currency market and effectively manage liquidity. However, the intended impact of this initiative has not materialized as expected. Despite the implementation of higher interest rates, numerous banks have actively engaged in accumulating deposits from their customers. Paradoxically, rather than achieving the desired reduction in liquidity, this surge in deposits has exacerbated the existing liquidity crisis in the country’s currency market.

An illustrative snapshot of the situation on October 25th reveals a record-breaking 24,455 crore taka held in banks’ accounts with Bangladesh Bank. Even on the subsequent day, this amount remained substantial, exceeding 18,000 crore taka. Remarkably, these funds were deposited at interest rates ranging from 7.25% to 9.25%. The adjustment in policy rates was strategically crafted to diminish the demand for money, but the unfortunate reality persists – the liquidity crisis shows no signs of abating.

The juxtaposition of increased interest rates and a burgeoning liquidity crisis underscores the complexity of managing the intricate financial ecosystem. The central bank’s intention to moderate liquidity by adjusting policy rates faces a challenging reality where banks, contrary to expectations, are actively accumulating funds. This unintended consequence prompts a closer examination of the broader economic landscape and the various factors influencing the behavior of financial institutions.

As stakeholders grapple with the persisting liquidity challenges, a critical evaluation of the effectiveness of current monetary policies is imperative. The incongruence between policy objectives and real-world outcomes highlights the need for a recalibration of strategies. Moving forward, a collaborative effort between regulatory bodies, financial institutions, and market participants may be essential to devise a more nuanced approach that not only aligns with the central bank’s objectives but also addresses the underlying dynamics contributing to the ongoing liquidity crisis.

Increase in Bank Deposits:

A significant portion of the public does not have savings
due to high inflation, leading to slower deposit growth. Additionally, the higher
interest rates are making it challenging for people to repay their loans,
contributing to an increase in default loans. This situation is weakening the
financial capacity of banks and raising concerns about the overall health of
the banking sector.

Sarwar Hossain, managing director of Dutch-Bangla Bank,
pointed out that depositors are seeking higher interest rates, making it
difficult for banks to attract deposits. As a result, the banks are borrowing
heavily from Bangladesh Bank to maintain their liquidity, despite the higher
interest rates.

While Bangladesh Bank’s intention to control inflation and
manage liquidity through interest rate adjustments and limiting the demand for
money is clear, the challenges in the country’s currency market persist. The
liquidity crisis continues to impact the banking sector, while inflation
remains a concern for essential commodities.

The policy rate hike and the adjustments in the SLF and SDF
rates have had mixed effects, and it’s evident that conventional monetary policies
are challenging to implement in an economy with a significant presence of
state-owned banks. A more comprehensive and nuanced approach may be necessary
to address these economic challenges effectively.

As the country grapples with the current economic situation,
it will be essential to carefully monitor the impact of these monetary policy
changes and consider alternative strategies to achieve long-term stability and
growth. The balance between controlling inflation and ensuring the smooth
functioning of the financial sector remains a complex challenge for
Bangladesh’s policymakers.

 Government Borrowing
from Commercial Banks:

In the intricate economic landscape of Bangladesh, several challenges have surfaced, prompting a closer examination of the role played by multiple banks in managing the country’s financial aspects. This article scrutinizes a notable development wherein the government is progressively relying on commercial banks for loans. Additionally, it explores the concurrent practice of the country’s central bank selling dollars to these banks and the subsequent impact on liquidity in the economy.

The escalating trend of the government turning to commercial banks for loans marks a significant shift in the financial dynamics of Bangladesh. Traditionally, governments resort to various means, including borrowing, to address fiscal needs, but the increasing dependence on commercial banks underscores a unique facet of the current economic scenario. Understanding the implications of this trend requires an exploration of the broader repercussions on both the banking sector and the overall liquidity of the economy.

As the government borrows from commercial banks, it injects a substantial amount of funds into the financial system. This influx of capital can have dual effects. On one hand, it provides the government with the necessary financial resources to meet its obligations and fund essential projects. On the other hand, it has a direct impact on the liquidity levels within the banking sector and, consequently, the broader economy.

Simultaneously, the country’s central bank engaging in the selling of dollars to commercial banks introduces another layer of complexity to the liquidity equation. While this practice may be a strategic move to manage the foreign exchange market and stabilize the national currency, its interplay with government borrowing adds intricacy to the overall liquidity scenario. The increased availability of funds in both local and foreign currencies can influence the lending capacity of banks, impacting interest rates and, consequently, liquidity conditions.

The collective impact of government borrowing from commercial banks and the central bank’s dollar-selling activities warrants careful consideration. It raises questions about the sustainability of such practices, potential risks associated with heightened liquidity, and the need for a balanced approach to ensure economic stability.

In navigating this evolving landscape, stakeholders, including policymakers, financial institutions, and regulatory bodies, must collaboratively assess the long-term ramifications of these practices. Striking a balance between meeting government fiscal needs and maintaining a stable economic environment will be crucial to fostering sustainable growth and resilience in the face of economic challenges.

 A Dual Challenge:

Bangladesh finds itself contending with a formidable dual challenge characterized by the twin issues of high inflation and its cascading impact on the financial landscape. The relentless rise in inflation has inflicted a severe blow to the purchasing power of ordinary citizens, creating a conundrum that has far-reaching consequences for both individuals and the banking sector.

The escalation of inflation has significantly heightened the cost of living, rendering it an arduous task for the average citizen to maintain their standard of living. As the prices of essential goods and services soar, the ability of individuals to save money is severely curtailed. This adverse effect on savings has a direct and palpable impact on the overall growth trajectory of bank deposits.

The repercussions of diminished savings are keenly felt within the banking sector, where the ability to expand credit portfolios is intimately linked to the influx of deposits. With citizens grappling with the economic strain induced by high inflation, the growth of bank deposits has been stunted, if not altogether hampered. In many banks, the trajectory of deposits has either stagnated or witnessed a decline, posing a formidable obstacle to the financial institutions’ capacity to extend credit and facilitate economic activities.

This dual challenge, characterized by the erosion of purchasing power and the stagnation of bank deposits, calls for a multi-faceted and strategic approach. Addressing the root causes of high inflation becomes imperative not only to alleviate the financial burden on citizens but also to stimulate savings and inject vitality into the banking system. Policymakers and financial institutions alike face the challenge of striking a delicate balance between controlling inflation and fostering an environment conducive to savings and credit expansion.

Navigating these intertwined challenges requires a collaborative effort, involving not only monetary authorities but also broader economic stakeholders. It necessitates a nuanced understanding of the intricate dynamics at play, with a focus on implementing comprehensive policies that not only curb inflationary pressures but also promote financial resilience and inclusivity. As Bangladesh grapples with this dual challenge, the path forward requires thoughtful strategies and concerted efforts to restore economic equilibrium and empower citizens to weather the inflationary storm.

Government Borrowing and Central Bank’s Role:

In the annals of the past fiscal year, a striking financial narrative unfolded as the government of Bangladesh, facing fiscal imperatives, borrowed a staggering BDT 97,684 crores from Bangladesh Bank, the central banking authority of the nation. What sets this borrowing spree apart is the manner in which it was facilitated – through the issuance of new currency notes by the central bank itself. As the new fiscal year dawns, the government is set to repay this substantial debt by resorting to another avenue – borrowing from commercial banks, with nearly BDT 30,000 crores already secured through this mechanism.

The modus operandi for this substantial borrowing is primarily rooted in the issuance of treasury bills and bonds, instruments through which the government can access capital from the financial markets. However, what complicates this financial maneuver is the discernible uptrend in the yields on these treasury bills and bonds. This surge in yields translates into increased costs for the government, amplifying the overall expenditure associated with its borrowing endeavors.

The interplay of government borrowing and the central bank’s pivotal role in facilitating this financial activity casts a spotlight on the broader economic landscape. The decision to print new currency notes to support government borrowing underscores the intricate relationship between fiscal policies and the actions of the monetary authority. While such measures may offer a short-term solution to meet immediate financial obligations, they also introduce complexities and potential long-term consequences.

As the government navigates its repayment commitments through borrowing from commercial banks, the dynamics of the financial market will be closely watched. The trajectory of yields on treasury bills and bonds becomes a critical metric, influencing the cost-effectiveness of government borrowing. Moreover, the central bank’s role in regulating and managing this intricate financial dance becomes paramount, requiring a delicate balance to ensure stability and avoid undue inflationary pressures.

The coming fiscal year is poised to be a pivotal period, where the consequences of the government’s borrowing decisions and the central bank’s interventions will unfold. Striking the right balance between meeting fiscal obligations and safeguarding the stability of the financial system will be an ongoing challenge, demanding vigilant oversight and thoughtful policy adjustments. As the nation steers through this financial landscape, the complexities inherent in government borrowing and the central bank’s role underscore the need for prudent and adaptive economic management.

The Impact on Money Markets:

The repercussions of the substantial government borrowing and the central bank’s role in facilitating this financial activity have sent ripples through the country’s interbank money market, where the day-to-day operations and liquidity dynamics have witnessed a significant impact. Daily transactions in this crucial market, often regarded as a barometer of financial health, have been notably constricted, hovering around a range of BDT 5,000 to 6,000 crores. On a recent trading day, the total volume in the interbank money market amounted to BDT 5,140 crores, reflective of the ongoing constraints.

One notable outcome of this constrained environment is the observable range in lending rates, which has fluctuated between 8% to 10%. This range is a manifestation of the intricacies arising from the interplay of government borrowing, central bank interventions, and the resultant limitations in liquidity.

Surprisingly, given the scarcity of surplus liquidity in the majority of banks, lending rates have not exhibited the expected upward trajectory that typically accompanies a shortage of funds. This atypical behavior can be attributed to the constraints faced by banks, particularly in the interbank money market, where the ability to extend credit becomes inherently restricted.

The interbank money market, traditionally a hub of financial activity and a critical conduit for liquidity, is now grappling with the constraints imposed by the prevailing financial landscape. The limited daily transactions and the fluctuating lending rates underscore the challenges faced by financial institutions in managing their liquidity positions.

Banks, constrained by the diminished availability of surplus liquidity, find themselves in a position where extending credit becomes a cautious endeavor, especially within the interbank money market. This cautious approach is reflected in the observed lending rates, which, despite expectations, have not seen a significant increase.

The impact on the money markets, therefore, becomes a microcosm of the broader economic challenges stemming from the intricate interplay of government fiscal policies, central bank interventions, and the resulting limitations on liquidity. As stakeholders navigate this complex financial terrain, a watchful eye on the developments in the interbank money market becomes crucial, offering insights into the resilience and adaptability of the financial system amidst the evolving economic landscape.

The Challenge of Inflation:

Bangladesh is currently grappling with the persistent challenge of rising inflation rates, exerting pressure on the prices of essential commodities and impacting the overall economic landscape. According to data sourced from the Bangladesh Bureau of Statistics (BBS), the inflation rate, as of the latest available data in September, registered at 9.63%. While this figure shows a marginal improvement compared to the previous month’s rate of 9.98%, it remains significantly higher than the desirable range. A year earlier, during the same period, the inflation situation in Sri Lanka, a neighboring nation, was relatively less severe, hovering just below 2%. In the neighboring Indian economy, the inflation rate stood at around 5%.

The persistent upward trajectory in inflation poses multifaceted challenges for Bangladesh’s economic stability. Essential commodities bear the brunt of this inflationary pressure, impacting the cost of living for ordinary citizens. The data indicates that, despite a slight dip from the previous month, the inflation rate is still elevated, warranting close attention from policymakers.

Comparisons with neighboring countries highlight the relative severity of Bangladesh’s inflationary challenge. While Sri Lanka was contending with a more moderate inflation rate a year earlier, and India experiencing a lower rate, Bangladesh faces a situation where inflation is notably higher, placing strain on both consumers and businesses.

Addressing the challenge of inflation requires a comprehensive understanding of the underlying factors contributing to the upward price pressures. Policymakers may need to explore a combination of monetary and fiscal measures to rein in inflation, ensuring a delicate balance that stimulates economic growth without exacerbating price volatility.

As Bangladesh navigates the complex landscape of inflation, it becomes imperative for economic stakeholders to devise strategies that not only mitigate the immediate impact on consumers and businesses but also contribute to sustained economic stability. The data underscores the urgency for vigilant economic management to steer the nation through these challenging times, fostering an environment conducive to both growth and stability.

Central Bank’s Efforts to Control Inflation:

The central bank of Bangladesh has assumed an assertive role in overseeing and managing the monetary dynamics within the country’s economy, with the pivotal responsibility entrusted to the Monetary Policy Division. Dr. Mohammad Ajazul Islam, at the helm of this division, has provided insights into the ongoing efforts to curb inflation, emphasizing the intricacies of this undertaking.

Dr. Islam acknowledged the complexity of the inflationary challenge, noting that its resolution is a gradual process. In his assessment, while certain prices have experienced an upward trajectory, others may witness a downward trend. The central bank is optimistic that the measures it has implemented will contribute to lowering the average inflation rate over time. Dr. Islam’s commentary underscores the nuanced nature of inflation management, requiring a strategic and patient approach.

Crucially, Dr. Islam emphasized the need for caution in the central bank’s actions, aiming to strike a delicate balance between curbing inflationary pressures and avoiding exacerbation of financial crises in the market. This cautious approach acknowledges the interconnectedness of various economic factors and the potential ripple effects that abrupt measures could have on the overall financial stability.

The central bank’s proactive involvement in managing the flow of money signifies a commitment to maintaining a stable economic environment. As the Monetary Policy Division navigates the intricacies of inflation control, their cautious stance reflects an understanding of the delicate equilibrium required to address economic challenges without inadvertently causing disruptions.

In conclusion, the central bank’s endeavors to control inflation demonstrate a comprehensive approach that considers the multifaceted nature of the economic landscape. Dr. Mohammad Ajazul Islam’s insights provide a glimpse into the strategic thinking underlying these efforts, highlighting the importance of measured actions to foster long-term economic stability while mitigating the immediate challenges posed by inflation.

Conclusion:

The economic landscape of Bangladesh stands at a crossroads, grappling with a dual challenge characterized by high inflation and restricted liquidity in the money market. The extensive borrowing by the government from banks, coupled with heightened dollar selling by the central bank, has introduced complexities that reverberate through the country’s financial stability.

In this intricate dance between fiscal policies and monetary interventions, Bangladesh Bank has actively sought to control inflation, recognizing the pressing need for economic stability. However, the ongoing challenges underscore the delicate balance required to navigate the current economic terrain successfully.

The substantial government borrowing, while providing immediate financial relief, has implications for liquidity, especially within the interbank money market. The increased selling of dollars adds another layer of complexity, influencing foreign exchange dynamics and further impacting the financial equilibrium.

Despite the earnest efforts of Bangladesh Bank, the persistence of inflation emphasizes the need for a nuanced and adaptive approach. Striking a balance between economic stability and addressing the exigent issue of rising prices becomes paramount. The multifaceted nature of these challenges necessitates a comprehensive strategy that not only curtails inflation but also safeguards liquidity and fosters sustainable economic growth.

As Bangladesh confronts these economic hurdles, finding equilibrium between these competing priorities is the key to charting a path forward. Collaborative efforts involving policymakers, financial institutions, and industry players will be crucial in devising and implementing strategies that foster resilience and navigate the complexities inherent in the current economic landscape. Achieving this delicate balance is essential for the sustained growth and stability of Bangladesh’s economy in the face of evolving challenges.