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MPS for H1 of FY18: Expectations

| Updated: October 25, 2017 02:54:40

MPS for H1 of FY18: Expectations

Bangladesh Bank is expected to announce its monetary policy statement (MPS) for the first half (H1) of fiscal year 2017-18 (FY1 18). I argued in the past that the effectiveness of monetary policy in Bangladesh is undermined by a number of structural characteristics of the financial system as well as the real economy of the country. These include the inability of the Central Bank to exercise any control over a significant part of broad money comprising net foreign assets and credit to the public sector, maintenance of persistently of high excess liquidity in the banking system, determination of interest rates on both deposits and advances through collusion among banks, weak response of interest rates to changes in broad money, low elasticity of private investment to interest rate changes and dominant influence of international prices on domestic inflation. 
More generally I also argued in the past that monetary policy generally is not effective in stimulating growth though it can exert notable influence in containing unsustainable growth. Recent paper by Stephen Roach, a faculty member of Yale University, USA (The Financial Express dated  July 04, 2017 page: 6) lends support to this view point. He writes "The most important lesson from the 1930s, as well as from the modern-day Japanese experience, is that monetary policy provides no answer for a chronic deficiency of aggregate demand".
In the past analysts have differed in branding a particular monetary policy statement as expansionary or contractionary. I do not find this controversy particularly meaningful. The reason is that monetary target fixed by Bangladesh Bank typically is based on the sum of government's real gross domestic product (GDP) growth rate and inflation rate. To this is added 3.0-4.0 per cent more in consideration of increased monetisation of the economy. Monetary Policy in Bangladesh is, therefore, always accommodating in nature.
Unlike the central banks of developed and many advanced developing countries Bangladesh Bank does not independently determine either GDP growth rate or inflation. 
In the context of discussion on monetary policy it is worth noting that in many countries the central bank is no longer charged with the responsibility of supervising the financial system. This task is performed by some other authority, presumably in close cooperation with the central bank. In Bangladesh the conduct of monetary policy as well as supervision of the financial system remains the responsibility of the central bank. My expectation from the upcoming monetary policy is that it will explicitly recognise the problems presently afflicting the financial system and give some indications of measures to deal with them. The following paragraphs shed light on some of these problems. 
First, the spread between interest offered on deposits and the rate charged on advances remains quite high despite some recent fall. The spread fell to 4.69 per cent in March 2017 compared to 4.79 per cent in July 2016. The prevailing spread is high by international standards and symptomatic of intermediation inefficiency. 
The second indicator of inefficient intermediation is high excess liquidity in the banking system the amount of which has persisted well over TK.1000 billion (100,000 crore) over the last two years. This means the banks are not making optimal use of their capacity to lend to the private sector for investment. 
The third malady is that real interest rate on deposits has become negative. Nominal interest rate on deposits in March 2017 was 5.01 per cent when annual average inflation was 5.41 per cent. It is, therefore, no surprise that deposit growth in banking system has slowed down. 
The fourth serious problem is the rising volume of classified loan. Its proportion of outstanding loan increased from 8.93 per cent in December 2013 to 10.53 per cent in March 2017. This is the highest proportion over the last nearly five years and this has happened despite fairly substantial rescheduling. 
The fifth problem is that many banks run the risk of not meeting required           risk-weighted capital adequacy ratios. According to a recent report of Bangladesh Bank as many as 37 banks will fail to meet this requirement if 10 top borrowers default.  
The sixth problem is that despite some fall in nominal interest growth of credit to private sectors has not picked up. In fact, the rate was lower during July-May 2017 compared to the same period of the previous year. 
A seventh problem the precise magnitude and the specific underlying causes of which are unclear relates to large-scale capital flight from Bangladesh reported by various international sources. 
Before concluding this brief paper I would like to mention a few other issues which have direct or indirect relevance to monetary policy. Export growth has plummeted, falling from 9.77 per cent in FY 16 to 1.69 per cent in FY 17. Remittances had a precipitous fall. It experienced a negative growth amounting to -14.48 per cent in FY 17 following a negative growth of -2.52 per cent in the previous fiscal year. Monetary Policy for H1 of FY18 should pay attention to the role of exchange rate in reversing these unfavourable outcomes. If it is determined that the nominal exchange rate should be devalued, its impact on inflation needs to be assessed. Finally, as already mentioned the growth of credit to the private sector has slowed down. Partly as a consequence private sector investment as a proportion of GDP has not shown any buoyancy. Monetary Policy needs to deal with measures needed to enhance the flow of credit to the private sector and to ensure that credit is used for productive investment. 
Dr. Mirza Azizul Islam, a former Advisor to the Caretaker Government, Ministries of Finance and Planning, is presently a Visiting Professor at BRAC University. maislam@bracu.ac.bd


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