Increasing the interest rate is critical to combat rampant inflation


Mir Md Tasnim Alam | Published: December 29, 2022 16:52:06


Increasing the interest rate is critical to combat rampant inflation

Since April 2020, our banks have offered a 9 per cent interest rate on all loans besides credit cards. Our deposit rate has also remained at 6 per cent. However, since then, the inflation rate in Bangladesh has averaged out to be 5.5%, which is considered a great success for Bangladesh's economy. 

Nonetheless, we are unable to keep things as they were, especially after the COVID outbreak, and our inflation has soared recently. According to data from Bangladesh Bank, the inflation of Bangladesh has gone up to 8.85% in Nov '22. 

In September, eleven banks in Bangladesh faced a combined capital shortfall of Tk 326 billion, underscoring the state of their precarious health brought on by years of irregularities. Bangladesh Bank can't give the banks some kind of special loan every time they face a liquidity crisis as the central bank doesn't have unlimited resources. 

In the worst-case scenario, Bangladesh Bank may have to go for quantitative easing to support the extra demand for the banks' capital. This will be detrimental as inflation is already surging. 

Recently we saw a price hike of Coal for no reason, which could pave the way for a subsequent step of raising the cost of electricity. The poor won't be able to survive if prices rise even a little bit further than their already difficult situation.

A 5.92% decline in liquidity across all the banks on October 22 as compared to June 22 was brought on by the panicked withdrawal of savings. The country's shariah-based banks can now obtain short-term loans under a new arrangement created by Bangladesh Bank, known as the 'Islamic Bank Liquidity Facility' to support the sudden liquidity crisis that the shariah-based banks are facing. 

The fact that the sharia-based banks are required to hold less liquid cash on hand than the other conventional banks while still experiencing a liquidity crisis can only mean one thing - the outflow of cash is outpacing the inflow, which is unfavourable given the current state of the economy. 

That being the case, the contractionary monetary policy should be implemented to reduce inflation and boost banks' liquidity. A contractionary monetary policy's best course of action should be to raise interest rates on both deposits and loans. The US Federal Reserve successfully used this strategy to contain the inflationary spiral.

Since 2012, the Federal Reserve of the United States has set the inflation rate at 2%. The Fed has mandated this new act to promote maximum employment and stable prices. When the inflation rate becomes challenging to control, the Fed employs its most powerful tool, interest rates, to control the monetary market and, thus, inflation. 

In the United States, inflation soared up to 9.1% in June 2022. The current inflation rate in the United States is 7.1%. The Fed could control inflation to some extent by raising the fed fund rate to 4%, the highest in ten years. The Fed fund rate, or interest rate, was only 0.4% in May this year.

A country's inflation is related to the amount of money it has in circulation. If there is more money circulating than production in that country, prices will go up as people attempt to buy products with the newly-created currency. 

Banks might raise interest rates in an effort to slow down this increase in inflation and keep it under control. Depositors generally make larger deposits, while lenders make smaller loans at higher interest rates. The central bank takes excess money out of the market and keeps inflation in check through this process. 

However, Bangladesh Bank is not handling the situation correctly, as it seems. The central bank recently raised the lending rate cap for consumer loans from 9% to 12%. Only 6% of the total loans in the banking industry are for consumer loans. 

The lending rate is still 9% for most loans, including business, corporate, and home loans. This means that, despite the current economic crisis, banks are still providing loans to businesses and luxuries at a rate of 9%. 

Additionally, the government wants to raise the money supply in our economy from 15.6% in the current FY23 to 16.5% in FY24, which may increase inflation further. 

To support the expanding business sector and economy, the government typically seeks to maintain the flow of money. For developing nations, having a controlled inflation level is a blessing. 

However, inflation ought to be in line with the nation's GDP. If no businesses are expanding or the economy is booming, expanding the money supply in the market is ineffective. This will only lead us to stagflation, inflation with unemployment, which is the worst a country can experience. 

Many nations are taking various actions to combat the crisis they are in. The Bangladeshi government has also taken numerous actions to reduce spending in numerous instances, which is entirely reasonable. 

However, it seems the government's frugal policy does not match up with our current monetary policy. A contractionary monetary policy, increasing the interest rate, can be the way out of this time of high inflation and liquidity crisis. 

Mir Md. Tasnim Alam is a researcher and writer

tasnimpksf@gmail.com

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