Originally posted in The Daily Star on 26 January, 2021
BB in a tight spot
It may need to continue expansionary monetary policy, which is creating excess liquidity amid lower credit demand
The central bank plans to continue its expansionary monetary policy in the second half of the current fiscal year because of the persistent business slowdown caused by the coronavirus pandemic.
The monetary policy committee of the central bank will sit on January 31 to decide whether the unconventional tools of the policy will be revised, said a number of central bankers with direct knowledge about the matter.
The major targets of the monetary policy for 2020-21 will not change to a large extent given the economic hardship, they said.
But economists termed the situation “very challenging” for the central bank to implement the monetary policy in the wake of an escalation of excess liquidity in the banking industry.
The central bank’s stance of continuing the expansionary monetary policy is justified, but it has to contain the excess liquidity at any cost, they said.
Although there is little probability of inflation escalating at this moment, the excess liquidity has already had an adverse impact on the interest rate of fixed deposit schemes, largely hovering between 3 to 4 per cent.
The excess liquidity at banks surged 95 per cent year-on-year to Tk 204,700 crore in December, data from the central bank showed.
Credit demand from borrowers is still subdued because of the uncertainty. As a result, the surplus liquidity has been on the rise in recent months.
In its monetary policy statement for fiscal 2020-21, the central bank set a private sector credit growth target of 11.5 per cent by December last year and of 14.8 per cent by June this year.
The central bank has already missed its credit growth target for the first half of the fiscal year as loans expanded by 8.37 per cent in December.
“If the economy does not rebound within June, the central bank will face a difficult situation to ease the pressure of the excess liquidity,” said Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh.
The central bank will face difficulty in implementing the monetary policy, he said. He, however, said that the central bank had to continue the expansionary monetary policy until June.
The BB began adopting unconventional tools of the monetary policy soon after the virus arrived on the shores of Bangladesh in March last year.
Both the central bank and the government have rolled out 23 bailout packages to absorb the economic shocks arising from the pandemic. The total amount of financial assistance stands at Tk 124,053 crore, which is 4.44 per cent of the gross domestic product.
The BB cut the repurchase agreement (repo) rate in phases to 4.75 per cent, from 6 per cent before the pandemic.
The repo rate is the rate at which the central bank lends to banks and is a major tool to understand the monetary policy of a central bank.
The bank rate, another tool of the central bank, was brought down by 100 basis points to 4 per cent in July, the first such cut in 17 years. The BB uses the rate while giving out money to banks under its refinance scheme.
All in all, the banking sector is flooding with excess liquidity.
Also, the upward trend of remittances has complicated the liquidity management of the central bank significantly, Mansur said.
In recent months, imports have declined while remittance has risen to record highs. It forced the central bank to purchase the dollar from banks by injecting the local currency into the market regularly.
The central bank has purchased the American greenback worth a record $5.49 billion in the first half of the current fiscal year to keep stable the exchange rate of the local currency.
The previous highest was recorded in 2013-14 when the BB bought $5.15 billion.
“The central bank should curb the upward trend of the excess liquidity right now by checking the remittances,” said Mansur, also a former official of the International Monetary Fund.
The remittance now being sent is not actual remittance. Instead, a large amount of remittance is flowing into the country in the form of portfolio investment by expatriate Bangladeshis, he said.
A portfolio investment is an ownership of a stock, bond, or other financial assets with the expectation that it will earn a return or grow in value over time, or both.
The majority of developed nations are in a deadlock of zero per cent interest rate due to the financial meltdown, and it will take them a couple of years to get rid of the ultra-low rate.
“The expatriates are now getting a better interest rate on the deposits kept in the banks in Bangladesh than the rates being provided by the lenders in the countries they live in,” Mansur said.
Remittance hit an all-time high of $21.74 billion last year.
The government should withdraw the 2 per cent cash subsidy against funds remitted by expatriates, Mansur said.
He urged the central bank not to inject reserve money by way of creating new stimulus packages.
Fahmida Khatun, executive director of the Centre for Policy Dialogue, said the government should start thinking of withdrawing the cash subsidy against remittance in the interest of common savers.
The government and the central bank should investigate to find out the persons who are sending remittance now, she said.
The surplus liquidity has brought woes for the depositors as the real interest rate has entered into negative territory, the economist said.
General inflation stood at 5.29 per cent in December whereas most banks offered interest rates from 3 per cent to 4 per cent on FDRs. This means the real interest rate is in a negative 2 per cent to 2.50 per cent.
“An asset bubble will occur in the financial sector in the months ahead if the excess liquidity is not checked right now,” Mansur said.
The asset bubble arises when the price of an asset, such as stocks, bonds, real estate, or commodities, rises at a rapid pace without the underlying fundamentals, such as equally fast-rising demand, to justify the price spike.
If the investment scenario does not receive a boost by June, the central bank would have to mop up money from banks, or else the situation may create stagflation, he said.
Stagflation refers to an economy experiencing a simultaneous increase in inflation and stagnation of economic output.
Nazneen Ahmed, a senior research fellow of the Bangladesh Institute of Development Studies, said inflation was still under control, which was a positive sign for the economy.
But the central bank should monitor the inflation cautiously due to the higher excess liquidity, she said.
“A proper implementation of the stimulus packages is crucial for the economy to make a recovery. The central bank monetary policy committee should take the issue with the utmost importance.”