Monetary policy of Bangladesh

MGT-301

Monetary policy of Bangladesh

MGT-301

Assignment
On
MACROECONOMICS
COURSE # MGT 301

Monetary policy of Bangladesh

Submitted to:
Dr. Faruq Ahmed
Professor,
Department of Management Studies,
University of Dhaka.

Submitted by:
Perpetual
Section: A
B.B.A. - 11th Batch
Department of Management Studies,
University of Dhaka.

Date of submission: 15-11-07

Monetary policy of Bangladesh

MGT-301

Name of Group Members

(Perpetual)

Serial
No

Name

Roll
No

Ramjanul Ahsan

02

Md. Masud Parvez

19

Md. Afzalur Rahman

31

Safayet Rahman

93

Monetary policy of Bangladesh

MGT-301

Letter of Transmittal

Dr. Faruq Ahmed

Professor,
Department of Management Studies,
University of Dhaka.
Subject: Submission of assignment papers.
Dear Sir,
It is an honor and great pleasure for us to submit our assignment on
monetary policy of Bangladesh. This assignment was assigned to us as
compulsory requirement of the course Macroeconomics (course #301) in
the 5th semester.
During the process of preparing our assignment, we had the chance of
experiencing and rediscovering our potentials. This assignment gave us
an opportunity to apply our theoretical expertise, sharpen our views, ideas
and communication skills, which will help us in our future professional
career.
Thanking you and looking forward to receive your cordial approval of
our submission.
Yours truly,
Perpetual
Section: A
B.B.A. - 11th Batch
Department of management studies,
University of Dhaka.

Monetary policy of Bangladesh

MGT-301

Table of Content
Monetary policy of Bangladesh
No.

Part 01 (Prologue)

Page No.

1.

Overview of the topics

05

2.

Definition of monetary policy:

06

3.

History of monetary policy

07

4.

Monetary policy theory

09

5.

Types of monetary policy

11

6.

Objectives of monetary policy:

15

7.

Tools used in determining the monetary policy

15

8.

Developing countries

16

Part 02 (Economic state of BD)

1.

Introduction

17

2.

Bangladesh : The Economic performance

20

3.

Development challenge

25

Part 03 (Monetary policy statement)

1.

Introduction

27

2.

Macroeconomic development :outcome and outlook

27

3.

Monetary policy stance

31

4.

Bibliography

34

Monetary policy of Bangladesh

MGT-301

Part 01
Prologue
1. Overview of the Topics
Monetary policy rests on the relationship between the rates of interest in an economy,
that is the price at which money can be borrowed, and the total supply of money.
Monetary policy uses a variety of tools to control one or both of these, to influence
outcomes like economic growth, inflation, exchange rates with other currencies and
unemployment. Where currency is under a monopoly of issuance, or where there is a
regulated system of issuing currency through banks which are tied to a central bank,
the monetary authority has the ability to alter the money supply and thus influence the
interest rate (in order to achieve policy goals). The beginning of monetary policy as
such comes from the late 19th century, where it was used to maintain the gold
standard.
A policy is referred to as contractionary if it reduces the size of the money supply or
raises the interest rate. An expansionary policy increases the size of the money supply,
or decreases the interest rate. Further monetary policies are described as
accommodative if the interest rate set by the central monetary authority is intended to
spur economic growth, neutral if it is intended to neither spur growth nor combat
inflation, or tight if intended to reduce inflation.
There are several monetary policy tools available to achieve these ends. Increasing
interest rates by fiat, reducing the monetary base, and increasing reserve requirements
all have the effect of contracting the money supply, and, if reversed, expand the
money supply. Since the 1970s, monetary policy has generally been formed separately
from fiscal policy. And even prior to the 1970s, the Bretton Woods system still
ensured that most nations would form the two policies separately.
Within almost all modern nations, special institutions (such as the Bank of England,
the European Central Bank or the Federal Reserve System in the United States) exist
which have the task of executing the monetary policy and often independently of the

Monetary policy of Bangladesh

MGT-301

executive. In general, these institutions are called central banks and often have other
responsibilities such as supervising the smooth operation of the financial system.
The primary tool of monetary policy is open market operations. This entails managing
the quantity of money in circulation through the buying and selling of various credit
instruments, foreign currencies or commodities. All of these purchases or sales result
in more or less base currency entering or leaving market circulation.
Usually the short term goal of open market operations is to achieve a specific short
term interest rate target. In other instances, however, monetary policy might instead
entail the targeting of a specific exchange rate relative to some foreign currency or
else relative to gold. For example in the case of the USA the Federal Reserve targets
the federal funds rate, the rate at which member banks lend to one another overnight.
The other primary means of conducting monetary policy include: (i) Discount
window lending (i.e. lender of last resort); (ii) Fractional deposit lending (i.e. changes
in the reserve requirement); (iii) Moral suasion (i.e. cajoling certain market players to
achieve specified outcomes); (iv) "Open mouth operations" (i.e. talking monetary
policy with the market).

2. Definition of monetary policy

Monetary policy is the process by which the government, central bank, or monetary
authority manages the supply of money, or trading in foreign exchange markets.
Monetary theory provides insight into how to craft optimal monetary policy.
Monetary policy is generally referred to as either being an expansionary policy, or a
contractionary policy, where an expansionary policy increases the total supply of
money in the economy, and a contractionary policy decreases the total money supply.
Expansionary policy is traditionally used to combat unemployment in a recession by
lowering interest rates, while contractionary policy has the goal of raising interest
rates to combat inflation (or cool an otherwise overheated economy). Monetary policy
should be contrasted with fiscal policy, which refers to government borrowing,
spending and taxation.

Monetary policy of Bangladesh

MGT-301

3. History of monetary policy

Monetary policy is associated with currency and credit. For many centuries there were
only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print
paper money to create credit. Interest rates, while now thought of as part of monetary
authority, were not generally coordinated with the other forms of monetary policy.
Monetary policy was seen as an executive decision, and was generally in the hands of
the authority with seignior age, or the power to coin. With the advent of larger trading
networks came the ability to set the price between gold and silver, and the price of the
local currency to foreign currencies. This official price could be enforced by law, even
if it varied from the market price.
With the creation of the Bank of England in 1694, which acquired the responsibility to
print notes and back them with gold, the idea of monetary policy as independent of
executive action began to be established. The goal of monetary policy was to maintain
the value of the coinage, print notes which would trade at par to specie, and prevent
coins from leaving circulation. The establishment of central banks by industrializing
nations was associated then with the desire to maintain the nation's peg to the gold
standard, and to trade in a narrow band with other gold back currencies. To
accomplish this end, central banks as part of the gold standard began setting the
interest rates that they charged, both their own borrowers, and other banks that
required liquidity. The maintenance of a gold standard required almost monthly
adjustments of interest rates.
During the 1870-1920 period the industrialized nations set up central banking
systems, with one of the last being the Federal Reserve in 1913. By this point the
understanding of the central bank as the "lender of last resort" was understood. It was
also increasingly understood that interest rates had an effect on the entire economy, in
no small part because of the marginal revolution in economics, which focused on how
many more, or how many fewer, people would make a decision based on a change in
the economic trade-offs. It also became clear that there was a business cycle, and
economic theory began understanding the relationship of interest rates to that cycle.
(Nevertheless, steering a whole economy by influencing the interest rate has often
been described as trying to steer an oil tanker with a canoe paddle.)

Monetary policy of Bangladesh

MGT-301

The advancement of monetary policy as a pseudo scientific discipline has been quite
rapid in the last 150 years, and it has increased especially rapidly in the last 50 years.
Monetary policy has grown from simply increasing the monetary supply enough to
keep up with both population growth and economic activity. It must now take into
account such diverse factors as:

short term interest rates;

long term interest rates;

velocity of money through the economy;

exchange rates;

credit quality;

bonds and equities (corporate ownership and debt);

government versus private sector spending/savings;

international capital flows of money on large scales;

Financial derivatives such as options, swaps, futures contracts, etc.

A small but vocal group of people advocate for a return to the gold standard (the
elimination of the dollar's fiat currency status and even of the Federal Reserve Bank).
Their argument is basically that monetary policy is fraught with risk and these risks
will result in drastic harm to the populace should monetary policy fail.
Most economists disagree with returning to a gold standard. They argue that doing so
would drastically limit the money supply, and throw away 100 years of advancement
in monetary policy. The sometimes complex financial transactions that make big
business (especially international business) easier and safer would be much more
difficult if not impossible. Moreover, shifting risk to different people/companies that
specialize in monitoring and using risk can turn any financial risk into a known dollar
amount and therefore make business predictable and more profitable for everyone
involved.

Monetary policy of Bangladesh

MGT-301

4. Monetary policy theory

It is important for policymakers to make credible announcements and degrade interest
rates as they are non- important and irrelevant in regarding to monetary policies. If
private agents (consumers and firms) believe that policymakers are committed to
lowering inflation, they will anticipate future prices to be lower than otherwise (how
those expectations are formed is an entirely different matter; compare for instance
rational expectations with adaptive expectations). If an employee expects prices to be
high in the future, he or she will draw up a wage contract with a high wage to match
these prices. Hence, the expectation of lower wages is reflected in wage-setting
behavior between employees and employers (lower wages since prices are expected to
be lower) and since wages are in fact lower there is no demand pull inflation
because employees are receiving a smaller wage and there is no cost push inflation
because employers are paying out less in wages.
However, to achieve this low level of inflation, policymakers must have credible
announcements, that is, private agents must believe that these announcements will
reflect actual future policy. If an announcement about low-level inflation targets is
made but not believed by private agents, wage-setting will anticipate high-level
inflation and so wages will be higher and inflation will rise. A high wage will increase
a consumer's demand (demand pull inflation) and a firm's costs (cost push inflation),
so inflation rises. Hence, if a policymaker's announcements regarding monetary
policy are not credible, policy will not have the desired effect.
However, if policymakers believe that private agents anticipate low inflation, they
have an incentive to adopt an expansionist monetary policy (where the marginal
benefit of increasing economic output outweighs the marginal cost of inflation).
However, assuming private agents have rational expectations, they know that
policymakers have this incentive. Hence, private agents know that if they anticipate
low inflation, an expansionist policy will be adopted that causes a rise in inflation.
Therefore, (unless policymakers can make their announcement of low inflation
credible), private agents expect high inflation. This anticipation is fulfilled through

Monetary policy of Bangladesh

MGT-301

adaptive expectation (wage-setting behavior) and so there is higher inflation (without

the benefit of increased output). Hence, unless credible announcements can be made,
expansionary monetary policy will fail.
Announcements can be made credible in various ways. One is to establish an
independent central bank with low inflation targets (but no output targets). Hence,
private agents know that inflation will be low because it is set by an independent
body. Central banks can be given incentives to meet their targets (for example, larger
budgets, a wage bonus for the head of the bank) in order to increase their reputation
and signal a strong commitment to a policy goal. Reputation is an important element
in monetary policy implementation. But the idea of reputation should not be confused
with commitment. While a central bank might have a favorable reputation due to good
performance in conducting monetary policy, the same central bank might not have
chosen any particular form of commitment (such as targeting a certain range for
inflation). Reputation plays a crucial role in determining how much markets would
believe the announcement of a particular commitment to a policy goal but both
concepts should not be assimilated. Also, note that under rational expectations, it is
not necessary for the policymaker to have established its reputation through past
policy actions; as an example, the reputation of the head of the central bank might be
derived entirely from her or his ideology, professional background, public statements,
etc. In fact it has been argued (add citation to Kenneth Rogoff, 1985.Hence the
reputation of a particular central bank is not necessary tied to past performance, but
rather to particular institutional arrangements that the markets can use to form
inflation expectations.

10

Monetary policy of Bangladesh

MGT-301

5. Types of monetary policy

In practice all types of monetary policy involve modifying the amount of base
currency (M0) in circulation. This process of changing the liquidity of base currency
through the open sales and purchases of (government-issued) debt and credit
instruments is called open market operations.
Constant market transactions by the monetary authority modify the supply of currency
and this impacts other market variables such as short term interest rates and the
exchange rate.
The distinction between the various types of monetary policy lies primarily with the
set of instruments and target variables that are used by the monetary authority to
achieve their goals.

Monetary Policy:
Inflation Targeting
Price
Targeting
Monetary

Target

Market

Variable:
Interest rate on overnight

debt
Level Interest rate on overnight
debt
The growth in money

Aggregates
supply
Fixed
Exchange The spot price of the
Rate

currency

Gold Standard

The spot price of gold

Mixed Policy

Usually interest rates

Long Term Objective:

A given rate of change in the CPI
A specific CPI number
A given rate of change in the CPI
The spot price of the currency
Low inflation as measured by the
gold price
Usually unemployment

CPI

change

The different types of policy are also called monetary regimes, in parallel to
exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The
Gold standard results in a relatively fixed regime towards the currency of other
countries on the gold standard and a floating regime towards those that are not.
Targeting inflation, the price level or other monetary aggregates implies floating
exchange rate unless the management of the relevant foreign currencies is tracking the
exact same variables (such as a harmonized consumer price index).
11

Monetary policy of Bangladesh

MGT-301

Inflation targeting
Under this policy approach the target is to keep inflation, under a particular definition
such as Consumer Price Index, within a desired range.
The inflation target is achieved through periodic adjustments to the Central Bank
interest rate target. The interest rate used is generally the inter-bank rate at which
banks lend to each other overnight for cash flow purposes. Depending on the country
this particular interest rate might be called the cash rate or something similar.
The interest rate target is maintained for a specific duration using open market
operations. Typically the duration that the interest rate target is kept constant will vary
between months and years. This interest rate target is usually reviewed on a monthly
or quarterly basis by a policy committee.
Changes to the interest rate target are made in response to various market indicators in
an attempt to forecast economic trends and in so doing keep the market on track
towards achieving the defined inflation target.
This monetary policy approach was pioneered in New Zealand. It is currently used in
the Euro zone, Australia, Canada, New Zealand, Norway, Poland, Sweden, South
Africa, Turkey, and the United Kingdom.

Price level targeting

Price level targeting is similar to inflation targeting except that CPI growth in one
year is offset in subsequent years such that over time the price level on aggregate does
not move.
Something akin to price level targeting was tried in the 1930s by Sweden, and seems
to have contributed to the relatively good performance of the Swedish economy
during the Great Depression. As of 2004, no country operates monetary policy based
on a price level target.

12

Monetary policy of Bangladesh

MGT-301

Monetary aggregates
In the 1980s several countries used an approach based on a constant growth in the
money supply. This approach was refined to include different classes of money and
credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued
with the selection of Alan Greenspan as Fed Chairman.
This approach is also sometimes called monetarism.
Whilst most monetary policy focuses on a price signal of one form or another this
approach is focused on monetary quantities.

Fixed exchange rate

This policy is based on maintaining a fixed exchange rate with a foreign currency.
There are varying degrees of fixed exchange rates, which can be ranked in relation to
how rigid the fixed exchange rate is with the anchor nation.
Under a system of fiat fixed rates, the local government or monetary authority
declares a fixed exchange rate but does not actively buy or sell currency to maintain
the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital
controls, import/export licenses, etc.). In this case there is a black market exchange
rate where the currency trades at its market/unofficial rate.
Under a system of fixed-convertibility, currency is bought and sold by the central
bank or monetary authority on a daily basis to achieve the target exchange rate. This
target rate may be a fixed level or a fixed band within which the exchange rate may
fluctuate until the monetary authority intervenes to buy or sell as necessary to
maintain the exchange rate within the band. (In this case, the fixed exchange rate with
a fixed level can be seen as a special case of the fixed exchange rate with bands where
the bands are set to zero.)
Under a system of fixed exchange rates maintained by a currency board every unit of
local currency must be backed by a unit of foreign currency (correcting for the
exchange rate). This ensures that the local monetary base does not inflate without

13

Monetary policy of Bangladesh

MGT-301

being backed by hard currency and eliminates any worries about a run on the local
currency by those wishing to convert the local currency to the hard (anchor) currency.
These policies often abdicate monetary policy to the foreign monetary authority or
government as monetary policy in the pegging nation must align with monetary policy
in the anchor nation to maintain the exchange rate. The degree to which local
monetary policy becomes dependent on the anchor nation depends on factors such as
capital mobility, openness, credit channels and other economic factors.

Managed Float
Officially, the Indian Rupee (INR) exchange rate is supposed to be 'market
determined'. In reality, the Reserve Bank of India (RBI) trades actively on the
INR/USD with the purpose of controlling the volatility of the Rupee - US Dollar
exchange rate - within a narrow bandwidth. (i.e. pegs it to the US Dollar)

Gold standard
The gold standard is a system in which the price of the national currency as measured
in units of gold bars and is kept constant by the daily buying and selling of base
currency to other countries and nationals. (i.e. open market operations, cf. above). The
selling of gold is very important for economic growth and stability.Today this type of
monetary policy is not used anywhere in the world, although a form of gold standard
was used widely across the world prior to 1971. For details see the Bretton Woods
system. Its major advantages were simplicity and transparency.

Mixed policy
In practice a mixed policy approach is most like "inflation targeting". However some
consideration is also given to other goals such as economic growth, unemployment
and asset bubbles. This type of policy was used by the Federal Reserve in 1998.

6. Objectives of monetary policy

14

Monetary policy of Bangladesh

MGT-301

Since monetary policy is one instrument of economic policy, its objective can not be
different from those of overall economic policy. The three important objectives of
monetary policy are:

i.
ii.
iii.

Ensuring price stability that is containing inflation.

To encourage economic growth.
To ensure stability of exchange rate of money, that is exchange rate of money
with other foreign currencies.

7. Tools used in determining the monetary policy

Monetary base
Monetary policy can be implemented by changing the size of the monetary base. This
directly changes the total amount of money circulating in the economy. A central bank
can use open market operations to change the monetary base.
The central bank would buy/sell bonds in exchange for hard currency. When the
central bank disburses/collects this hard currency payment, it alters the amount of
currency in the economy, thus altering the monetary base.
Reserve requirements
The monetary authority exerts regulatory control over banks. Monetary policy can be
implemented by changing the proportion of total assets that banks must hold in
reserve with the central bank.
Banks only maintain a small portion of their assets as cash available for immediate
withdrawal; the rest is invested in illiquid assets like mortgages and loans.By
changing the proportion of total assets to be held as liquid cash, the Federal Reserve
changes the availability of loan able funds. This acts as a change in the money supply.

Discount window lending

15

Monetary policy of Bangladesh

MGT-301

Many central banks or finance ministries have the authority to lend funds to financial
institutions within their country. By calling in existing loans or extending new loans,
the monetary authority can directly change the size of the money supply.
Interest rates
The contraction of the monetary supply can be achieved indirectly by increasing the
nominal interest rates. Monetary authorities in different nations have differing levels
of control of economy-wide interest rates. In the United States, the Federal Reserve
can set the discount rate, as well as achieve the desired Federal funds rate by open
market operations. This rate has significant effect on other market interest rates, but
there is no perfect relationship.In other nations, the monetary authority may be able to
mandate specific interest rates on loans, savings accounts or other financial assets. By
raising the interest rate(s) under its control, a monetary authority can contract the
money supply, because higher interest rates encourage savings and discourage
borrowing. Both of these effects reduce the size of the money supply.

8. Developing countries
Developing countries may have problems operating monetary policy effectively. The
primary difficulty is that few developing countries have deep markets in government
debt. The matter is further complicated by the difficulties in forecasting money
demand and fiscal pressure to levy the inflation tax by expanding the monetary base
rapidly. In general, central banks in developing countries have had a poor record in
managing monetary policy. This is often because the monetary authority in a
developing country is not independent of government, so good monetary policies
takes a backseat to the political desires of the government or are used to pursue other
non-monetary goals. For this and other reasons, developing countries that want to
establish credible monetary policy may institute a currency board or adopt
dollarisation. Such forms of monetary institutions thus essentially tie the hands of the
government from interference and, it is hoped, that such policies will import the
monetary policy of the anchor nation.

16

Monetary policy of Bangladesh

MGT-301

Part 02
Economic state of BD
1. Introduction of Monetary policy of Bangladesh
Monetary Policy the policy adopted by the central bank for control of the supply of
money as an instrument for achieving the objectives of general economic policy. As
stated in the Bangladesh Bank Order 1972, the principal objectives of the country's
monetary policy are to regulate currency and reserves; to manage the monetary and
credit system; to preserve the par value of domestic currency; to promote and
maintain a high level of production, employment and real income; and to foster
growth and development of the country's productive resources in the best national
interest. Although the long term focus of monetary policy in Bangladesh is on growth
with stability, the short-term objectives are determined after a careful and realistic
appraisal of the current economic situation of the country.
At 6% over the past 4 years, strong GDP growth has been underpinned by more
market-oriented economic policies, a dynamic garment sector, and substantial inflows
of overseas workers remittances. The lead-up to the parliamentary elections was
generally expected to be a rough patch given the countrys contentious political
environment; the constitutional mechanism of a neutral caretaker government was
expected to help smooth the way. Deepening political deadlock culminated with the
president in January declaring a state of emergency and calling o? the elections. But
the new caretaker Government has continued with established economic policies and
expedited structural and sector reforms. It has taken a broad agenda of activity,
including an extensive anticorruption drive that it sees necessary to establish better
foundations for holding the elections. GDP is forecast to maintain its recent
momentum over the medium term.
With the shifts of the policy stance of the government in various phases, necessary
adjustments were made in the country's monetary policy. In the first years after
liberation, the primary target of monetary policy was to regulate not the quantity of
money, but the direction of the flow of money and credit in support of the government
financial programme. In 1975, Bangladesh entered into a standby-arrangement with

17

Monetary policy of Bangladesh

MGT-301

IMF and the country's monetary policy got a changed shape, which fixed an explicit
target of safe limit of monetary expansion on annual basis. With this change,
BANGLADESH

BANK

started setting short-term objectives of monetary policy in close

collaboration of the government and tried to achieve the target by using the direct
instrument of control. The principal target of monetary control was broad money (M2)
ie, the sum of the currency in circulation and total deposits of money in banks. The
targeted growth of M2 depended on a realistic forecast of the growth rate of real GDP,
an acceptable rate of inflation and an attainable level of international reserves.
Bangladesh Bank took measures to monitor credit and monetary expansion keeping in
view the price situation and international reserves position. Efforts were made to
achieve the targeted growth of domestic credit and thereby, the money supply, through
imposing ceilings on credit to the government, public, and private sectors. The major
policy instruments available to Bangladesh Bank were to set credit ceiling on the
banks and provide liberal refinance facility at concessional rate for priority lending.
According to the national economic policy, the banks were to provide the desired
volume of credit at an administered and low rate of interest. In that situation,
Bangladesh Bank practically did not have any effective instrument for making
adjustments in the growth of money supply or for transmitting market signals into
changes in money supply. The monetary policy therefore, could not function in its true
sense. As a result the BANKING SYSTEM could not play its role as an effective financial
intermediary.
In 1989, the government adopted a comprehensive Financial Sector Reform
Programme (FSRP), following which the country's monetary policy assumed a new
orientation towards promotion of market economy in a competitive environment.
Bangladesh Bank started moving away from direct quantitative monetary control to
indirect methods of monetary management since the beginning of 1990. Major
instruments of monetary control available with Bangladesh Bank are the bank rate,
open market operations, rediscount policy, and statutory reserve requirement.
Bank rate Until 1990, the use of this instrument as the lending rate of the central bank
for borrowings of the commercial banks to meet their temporary needs was virtually
non-existent in Bangladesh. The rate was changed in a few occasions only to align it
with the refixation of the rates of deposits and advances. Moreover, the existence of
18

Monetary policy of Bangladesh

MGT-301

refinance facilities at rates lower than the bank rate substantially eroded its
significance. However, since 1990, the instrument has been put in use to change the
cost of borrowings for banks and thereby to affect the market rate of interest. Bank
rate was gradually lowered from 9.75% in January 1990 to 5% in March 1994. It was
raised to 5.75% from 10 September 1995 and further, to 7.5% and 8% from 19 May
1997 and 20 November 1997 respectively. The rate was lowered to 7% from 29
August 1999.
Open market operations (OMO) These involve the sale or purchase of securities by
the central bank to withdraw liquid funds from the banking system or inject the same
into that system. OMO allows flexibility in terms of both the amount and timing of
intervention, which did not exist in Bangladesh before 1990. Bangladesh Bank
introduced a 91-day Bangladesh Bank Bill, a market-based tool for monetary
intervention, in December 1990. The bank bill was subsequently withdrawn from the
market. At present, OMO operations are conducted through participation of banks in
monthly or fortnightly/weekly auctions of TREASURY BILLs.
Rediscount policy After the introduction of FSRP, the refinance facility was replaced
by rediscount facility at bank rate to eliminate discrimination in access to central bank
funds. Refinance facility is now available for agricultural credit provided by
BANGLADESH KRISHI BANK

financed by

SONALI BANK .

and for projects of Bangladesh Rural Development Board

Banks are advised to extend credit considering banker-

customer relationship.
Statutory reserve requirement Cash reserve requirement (CRR) of the deposit money
banks has a significant potential to regulate money supply through affecting money
multiplier, while statutory liquidity requirement (SLR) is generally used to affect the
lending capability of the bank. Bangladesh Bank used these two instruments very
infrequently before 1990 and very often after 1990. The CRR and SLR were 8% and
23% respectively on 25 April 1991 and were reduced to 7% and 22% respectively on
5 December 1991. Later, these rates were changed twice and set at 5% and 20%
respectively on 24 May 1992. The CRR was further lowered to 4% from 4 October
1999. The downward revision in CRR and SLR were made to enable the banks to
increase their lending capacity.

19

Monetary policy of Bangladesh

MGT-301

2. Bangladesh: The Economic performance

Growth in GDP has trended up in recent years, reaching 6.7% in FY2006 (ended 30
June 2006), driven by improved domestic and external demand. his performance was
reflected in a steady expansion in industry, lifted by export-oriented manufacturing,
and in continued services buoyancy . A marked reduction in poverty accompanied
growth: the headcount poverty rate declined by about 1.8 percentage points a year
between 2000 and 2005 to 40%, compared with a decline of only about 1 percentage
point a year in the preceding decade. The improvement was somewhat faster in rural
than urban areas. Rising access of the poor to micro credit, a rapid expansion in
overseas workers remittances, and improvements in physical and social infrastructure
all contributed to the sharp drop in poverty. In FY2006 on the expenditure side,
private consumption propelled growth. Investment rose by 0.5 percentage points to
25.0% of GDP, bolstered by a rise in private investment. Gross national savings
increased by 0.8 percentage points to 26.6% of GDP, lifted by a rise in workers
remittances.

Net exports of goods and services remained negative. Inflation moved up steadily to
average 7.2%. This exceeded the 7.0% limit set by Bangladesh Bank, the central
bank, in its first Monetary Policy Statement (MPS) issued in January 2006. Demand
pressures generated by excess money, a sharp depreciation in the taka (Tk) against the
US dollar (of 8.5% in FY2006), and a rise in global commodity prices (including oil),

20

Monetary policy of Bangladesh

MGT-301

all heightened inflationary pressures. Rising exports of some consumer items, pulling
their domestic prices to higher global levels, also added to price pressures.

Despite attempts to tighten monetary policy, both money and credit aggregates
expanded rapidly in FY2006. Broad money grew by 19.5%, as against the MPS
program target of 14.3% and prior-year actual growth of 16.8%. Private sector credit
grew sharply because of rising credit demand in support of domestic economic
activity, while the public sector borrowed in excess of the credit target, mainly to
finance the high cost of imports by state-owned Bangladesh Petroleum Corporation
(BPC). To tighten credit, Bangladesh Bank raised key policy rates over the course of
the year: the 28-day treasury bill rate from 6.6% in the last quarter of FY2005 to 7.1%
in the last quarter of FY2006, and the reverse repo rate from 4.5% in June 2005 to
6.0% in June 2006. Yet because of excess liquidity in the system, these measures
failed to fully restrain credit growth. he second MPS, announced in mid-July 2006,
again aimed to tighten monetary policy, both to control inflation and to ease pressures
on the exchange rate, at the same time sustaining domestic output growth. The
introduction of the MPS is a welcome development as it seeks to bring greater
predictability to the policy regime and to avoid policy surprises, which should aid the
private sector in making its investment decisions. However, to derive greater benefit
from the MPS, the Government needs to allow Bangladesh Bank greater operational
autonomy and to establish greater coordination between monetary and fiscal policies.
At 3.3% of GDP, the central government deficit in FY2006 came in below the
budgeted 4.5%. this was because of lower than planned growth in both current and
development expenditures, and in spite of underperformance in revenue collection.

21

Monetary policy of Bangladesh

MGT-301

Current expenditures were lower as a result of tighter budgetary discipline and

reductions in unproductive outlays through austerity measures.

Development spending was kept at a lower than projected level by large cost
reductions in non priority projects, fewer unproductive expenditures, and slow project
implementation. Revenues fell short of target because expected increases in collection
arising from reforms and administrative improvements failed to materialize. So while
tax-reform efforts yielded some gain in domestic value-added tax and income tax
collection, overall targets were missed in part because of lower customs receipts
stemming from tariff cuts. Domestic financing (borrowing from bank and non bank
sources) of the budget deficit amounted to 2.1% of GDP, while foreign assistance
(both loans and grants) financed the remaining 1.2%.he exchange rate came under
increasing pressure during much of FY2006, because of slowing financial account
inflows and higher import prices for oil and some other products. the currency
stabilized in the last quarter of the fiscal year, as the tighter monetary policy started to
have an effect, and the current account strengthened notably. the exchange rate stood
at Tk69.7/$1 in June 2006, representing an 8.5% depreciation against the US dollar in
FY2006. he marked depreciation in the nominal rate offset Bangladeshs higher
inflation relative to its trading partners, and the real effective exchange rate of the taka
depreciated by 5.3% in FY2006, boosting the countrys external competitiveness.
Import growth fell sharply to 12.1% in FY2006 from 20.6% in FY2005 as
administrative controls on letters of credit were imposed and unproductive imports
discouraged. In addition, lower imports of food grains and most other edible products
offset higher imports of oil, industrial raw materials, and capital machinery. Export
growth surged to 21.6% from 14.0%, reflecting robust performance of knitwear and
22

Monetary policy of Bangladesh

MGT-301

woven garments. A decline in the trade deficit and a steep rise in remittances (24.8%)
turned the current account balance from a deficit of 0.9% of GDP to a surplus of
0.9%. Foreign exchange reserves rose to $3.5 billion at end-June 2006 from $2.9
billion a year earlier. In the FY2007 budget (announced in June 2006), the
Government shaved duties on intermediate goods from 13% to 12% and on raw
materials from 6% to 5%, as part of trade reforms agreed with the World Bank. It also
cut supplementary duties. these measures should improve profitability and
competitiveness of domestic industries, though they add to the effort needed to raise
the budgets low revenue ratio. Financial sector reforms to strengthen the regulatory
and supervisory framework for banks made headway in 2006, though at a slower than
expected pace. he health of the banking system has improved since
2002, as seen in the declines in gross nonperforming loans (NPLs) from 28% to 14%
and in net NPLs (i.e., less provisions) from 21% to 8%. This led to significant rises in
profitability ratios. Although the private commercial banks improved to record low
NPLs of 6%, the four nationalized commercial banks (NCBs) are still weak and show
very high NPLs of 25%. he NCBs have large capital shortfalls with a risk-weighted
capital asset ratio of just 0.5% in June 2006 (as against the required 9%), compared
with 10% for the private banks. the performance of the four NCBs is monitored under
memorandums of understanding signed by each of them and the central bank, in
relation
to tightened prudential norms and lending limits. It has been mixed, though, in part
because of government-directed extensions of credit, particularly to BPC to finance its
higher import costs. the divestment of Rupali Bank, an NCB, moved forward and the
sales and purchase agreements are expected to be signed. the Government has taken
steps to corporatize the remaining NCBs and make them more autonomous while
keeping them under the regulatory purview of the central bank, with an eye on their
eventual privatization. Other areas have shown progress. Bangladesh Bank has
completed a comprehensive plan to switch over to the new international standard
framework for assessing banks capital adequacy under Basel II, which the
Government intends to implement from early 2009. It established a settlement system
for secondary bond trading in May 2005 and introduced mark-to-market valuation
guidelines for treasury securities effective February 2006, which have improved
operations of the inter bank and treasury bill markets. It also introduced market-based
auctions of treasury bills in September 2006 to bring greater flexibility to liquidity
23

Monetary policy of Bangladesh

MGT-301

management. Unlike many other bourses in Asia, the Dhaka Stock Exchange has not
recorded significant gains, though January 2007 saw a rise in response to prospects of
an improved political situation. Still, as indicated by the low 7.5% market
capitalization-to-GDP ratio, the equity market remains underdeveloped, largely
because of weak corporate governance, lack of high-quality share listings, and a
dearth of large institutional investors. While governance issues need to be tackled,
increasing the supply of listed shares by privatizing state enterprises through public
share offerings would help boost market capitalization and trading activity. Two major
power sector entitiesDhaka Electric Supply Company and the Power Grid
Company of Bangladeshhave already set an example by selling shares in the equity
market in 2006, under the Governments broader goal of privatizing state enterprises.
Modernization of the National Board of Revenue gathered pace. Large taxpayers
units for value-added tax and income tax have already been established in Dhaka, and
branches of these units are being set up in Chittagong (the second biggest city and
main port). he board is being reorganized along functional lines and an audit cell has
been set up. the central intelligence cell has detected several tax evasion cases and
secured unpaid taxes. these actions are expected to strengthen the tax machinery and
raise revenues over the medium term. In an attempt to curb corruption among tax
officials and redress taxpayers grievances, the countrys first tax ombudsperson was
appointed in July 2006.The Customs House in Chittagong is being split into two
entities to strengthen customs administration: one for imports and one for exports.
Computerization of customs administration has improved tax assessment and
appraisal functions.

24

Monetary policy of Bangladesh

MGT-301

3. Development Challenges
Key development challenges facing Bangladesh include upgrading the physical
infrastructure, augmenting efficiency in the financial sector, stimulating greater
foreign direct investment (FDI), and strengthening governance. Deficiencies in key
infrastructure, such as power, ports, railways, and roads, seriously hamper export
growth, investment, and opportunities for transport integration with neighbors.
In the ports segment, Chittagong port, which handles nearly 85% of imports and 80%
of exports, suffers from low productivity, labor problems, and weak management,
exacerbated by the practice of stuffing and unstuffing containers in the port (because
of limited of-dock facilities and costly railway services to move containers).
Chittagong port
is below the UNCTAD productivity standard of 230 lits per berth a day. Bangladesh
Railway is unable to carry containers efficiently and on time because of limited
locomotive and freight-car availability, congested network on major corridors such as
DhakaChittagong and the corridor to India, lack of operational efficiency, and
infrastructure constraints. he main constraints facing the road sector are inadequate
maintenance funding and weak management.
As a result of weaknesses in transport operations, the country is tardy in exporting and
importing, requiring 35 and 57 days, respectively, measured from start to completion
of export/import procedures and shipment. his compares ill with neighboring
countries such as India (27/41 days export/import, respectively), Pakistan (24/19
days), and Sri Lanka (25/27 days). Similarly, costs are high. For example, the cost of
export for each container in Bangladesh is $902, compared with $864 in India, $797
in Sri Lanka, $481 in Malaysia, and $335 in the Peoples Republic of China.For
Chittagong port, the focus should remain on contracting out operations to the private
sector, on allowing private operators to invest iport infrastructure, and on restructuring
its management. The caretaker Government has, in fact, transferred the operations of
Chittagong container terminal to the private sector, and has also signaled its intention
to do the same for the new mooring container terminal. For Bangladesh Railway, the
emphasis should be on ensuring greater commercial orientation, outsourcing some
business to private companies and introducing modern management and financial
systems. In roads, the priority should be on approving an integrated multimodal
transport policy and creating a road maintenance fund. Despite some progress,

25

Monetary policy of Bangladesh

MGT-301

Bangladesh is yet to establish a healthy and efficient financial system. Ongoing

banking sector restructuring must be strengthened. In the capital market, the thrust
should be on improving financial reporting and corporate governance, and
strengthening monitoring and enforcement by the Securities and Exchange
Commission. Many government-owned enterprises, including the petroleum
distribution companies and Biman Bangladesh Airlines, as well as major private
companies such as mobile phone companies with huge annual turnover, could be
prime candidates for selling shares stimulating the equity market. From already low
levels, FDI inflows further declined in FY2006, depriving the country of muchneeded capital resources along with the associated transfer of technology, skills, and
access to new export markets. Despite the seriousness of the position, the country is
yet to accord political decisions on several large FDI proposals. Corruption is an
important factor that prevents Bangladesh from achieving its potential for higher
economic growth and faster poverty reduction. he caretaker Government has taken an
extensive anticorruption stance, and as part of this will need to address the
shortcomings of the Anticorruption Commission, giving it greater independence,
scope, and resources.

26

Monetary policy of Bangladesh

MGT-301

Part 03
Bangladesh Bank
Monetary policy statement
1. Introduction:
Following a strong growth of 5.4 percent in 2006, global output growth is projected to
be 4.9 percent in 2007 (WEO, April '07, IMF); while developing world would grow
by 7.0 percent. Economic growth in Bangladesh has also got its momentum like its
neighboring countries. Bangladesh experienced a real GDP growth of 6.63 percent in
FY 06. The growth projection for current fiscal year is 6.5 percent. The policy
strategy recently initiated and the reform programs undertaken by the government
would not only help the economy to grow by 7.0 percent in FY08 but also pave the
way for Bangladesh to become a member of the middle income group country by
the end of the next decade.

2. Macroeconomic development: outcome and outlook

Growth: During the last three years real GDP grew on an average at above 6.0
percent up to FY 06. The growth momentum though expected to continue in FY07,
the revised estimate of GDP growth rate has been revised lower to 6.5 percent from
the projected range of 6.56.8 percent largely reflecting setback in agriculture that
faced supply failure of fertilizers, shortages of power for irrigation and inadequate
rainfall. Production of aus and aman crops were 1.51 million and 10.80 million tons in
FY07 against 1.75 million and 10.80 million tons respectively in FY 06. Output of
Boro, the largest crop in the year, is estimated at 14.50 million tons compared to 14.00
million tons in FY 06. Production of maize has increased as farmers have largely
substituted maize for wheat. The latest estimate of overall food grain production is
about 27.54 million tons, slightly above than that of the last year and less than the
target 32.27 million tons for FY07.

27

Monetary policy of Bangladesh

MGT-301

Growth in the industry sector continues to be robust in FY07 owing to steady growth
in export-oriented manufacturing and increased domestic demand. Looking at the
growth trend of quantum index of manufacturing industries, it is expected that the
growth in the industry sector would be within 10.0-10.5 percent. The buoyancy of
growth in industry is supporting corresponding growth in the service sector. The
accelerated pace of growth in the transport and communications sector would likely
offset the apparent slow down in the construction and real estate sector.

Overall GDP growth, according to forecast for FY08, is expected to regain its
momentum mainly representing the conducive economic and political environment
created by the present government. Growth in the agriculture sector in FY08 is thus
likely to be higher than that in FY07 aided by the projected higher disbursement of
agricultural loans and supportive measures cited above. The industry sector is
expected to continue to show robust performance in FY08 mainly due to steady
growth in export-oriented manufacturing and new capacity addition especially in the
telecommunications and the energy sectors. Increase in import of industrial raw
materials (12.2 percent) and capital machinery (16.6 percent) during July 06May '07
indicate that industry sector growth will sustain. The service sector is likewise
expected to experience buoyant growth in FY08. Overall, real GDP growth in FY08 is
28

Monetary policy of Bangladesh

MGT-301

projected to be 7.0 percent in line with the projection in the Medium Term
Macroeconomic Framework (MTMF).
Inflation: FY07 commenced with an average inflation rate of 7.16 percent but eased
to 6.72 percent by the end of January, '07 reflecting both seasonality and restrictive
monetary policy that was pursued. Inflation projection for FY07 was lowered from
7.0 percent to a range of 6.85-6.95 percent in the Monetary Policy Statement
announced in January 2007. In the international front, prices of fuel, metals, food
grains and other essential commodities soared, while in the internal front, selective
depreciation in the exchange rate, revision of fuel prices, production shortfall of food
items and political unrest, some of which have already been subdued, put pressure on
the prices. Inflation rate, on an average basis, went up to 7.06 percent in May '07
(8.05 percent on point-to-point basis). Inflationary pressure was mainly felt on the
food component, which went up to 8.02 percent at the end of May '07 from 7.56
percent at the end of January '07 while non-food inflation rose slightly to 5.67 percent
at the end of May '07 from 5.53 percent at the end of January '07.

Apart from steps to monitor supply in domestic markets, the government has taken
price stabilization measures to ease the pressure which include withdrawal of duties,
importation of food grain by the government, strengthening of internal procurement,
provision for subsidy on fertilizers and diesel and widening of the Social Safety Net
Programme. Besides, banks are now providing credit facilities on softer terms to new

29

Monetary policy of Bangladesh

MGT-301

importers, easing the LC margin for food items, extending time limit for customer
facility and arranging higher agricultural credit. Since global commodity prices are
not projected to fall in 2008 (WEO, IMF, April 2007) these measures may only
slightly lessen the pressure on consumer prices. Hence monetary stance of the
Bangladesh Bank over the coming quarters will continue to target the containment of
annual average inflation within a range of 6.57.0 percent for FY08.
External sector: Exports and imports grew by 18.50 percent and 17.83 percent
respectively, year on year basis in first ten months of FY07. Growth in workers
remittances was also steady at 24.52 percent up to June '07. Surplus in the current
account balance emanating mostly from robust growth in exports and workers
remittances inspite of higher growth in imports helped releasing pressure in foreign
exchange market that prevailed in the last part of H1 FY07.
With the marked increase in supply of foreign currency the foreign exchange reserves
continued to build up to reach an all time high of 5.1 billion US dollar. Mirroring
floating exchange rate management, the exchange rate of taka against US dollar,
amidst fluctuations, appreciated by 1.26 percent to Tk. 68.80 at the end June '07 from
Tk. 69.67 at the end June 06.
Some downside risks in the global perspective in FY08 remains the main concern
affecting external sector outlook. Besides, it has been apprehended that export sector
of Bangladesh may bear some pressure with the end of restrictions on Chinese
apparels by the end of 2007. However, increased flow of remittances, probable higher
FDI flow, reasonable export growth and normal import trend are expected to persist in
FY08. Bangladesh Bank will continue to use its monetary policy tools, if necessary, to
sterilize liquidity to emanate from expected higher foreign currency inflows.
Fiscal Sector: The overall deficit in the revised budget of the government for FY07
remained the same as in the original estimate and amounted to Tk. 173.64 billion or
3.7 percent of GDP, funded by Tk. 73.33 billion in foreign loans and grants and Tk.
100.31 in domestic borrowings including bank borrowing of Tk. 65.31 billion. Actual
outturn in bank borrowing is less at Tk. 59.8 billion as on 30 June '07. The budget for
FY08 projects an overall deficit of Tk. 223.13 billion or 4.2 percent of GDP, to be
30

Monetary policy of Bangladesh

MGT-301

funded by Tk. 42.55 billion in foreign grants, Tk. 63.05 billion in foreign loans and
Tk.117.53 billion in domestic borrowing including bank borrowing of Tk. 72.53
billion. BPCs accumulated loss of Tk. 75.23 billion is included in the budget. As
indicated in the budget this will not create immediate additional fiscal liabilities as it
will be financed by a Non-Cash Bond issue.
From the beginning of FY07, a modified arrangement of Governments bank
borrowings was put in place under the supervision of a Cash and Debt Management
Committee (CDMC) chaired by Secretary, Finance Division. The new arrangement
included a widened Ways and Means Advance Limit (Tk. 10.00 billion instead of Tk.
0.65 billion) and auction of treasury bills and bonds according to volumes preannounced in the borrowing calendar. This new arrangement segregated BBs role in
government debt management from its monetary policy operations but there is no inbuilt mechanism to limit government bank borrowings within the ceiling of budgetary
provisions.
Until now, following the changed treasury rules BB holds treasury bills and bonds at
cut off rate if market supply of fund falls short of Governments demand set by
CDMC (which is known as devolvement). From the 4th quarter FY07, BB was
allowed to offload the devolved amount to the banks and financial institutions at the
cut off rate of last auction for the remaining period.
Recently the CDMC has agreed in principle that from the beginning of FY08 the
devolvement system will be replaced by a system where the extra amount will be
devolved on the primary dealers on the basis of underwriting. This new system will
enthuse the primary dealers to create a secondary market for government securities.
The new system will make it easier for BB to improve its monetary management.

3. Monetary Policy Stance

Recent Monetary Developments: Bangladesh Bank has been continuing to pursue a
cautious, restrained monetary stance since H2 FY05 with a view to curbing excess
demand from inflationary expectations.

31

Monetary policy of Bangladesh

MGT-301

An upward bias in policy interest rates and reintroduction of BB bills in October 2006
helped in limiting inflation around the targeted seven percent despite international
price pressure. In spite of cautious monetary policy, M2 year-on-year growth (18.2
percent) at the end of May '07 exceeded the end-June target (14.7 percent), growth
rate of private sector credit that mirrors a part of the aggregate demand grew at 15.6
percent which was lower than previous years growth rate of 17.1 percent. Net foreign
assets of banking sector has been continuing to grow at a rate leading to the build up
of foreign exchange reserves that reached $ 5.1 billion by the end of June '07.
BB has been continuing to follow the cautious monetary stance with a view to
ensuring that the existing inflation is not further fuelled by increased aggregate
demand. However, BB is committed to ensuring flow of credit in the productive
sectors like agriculture, small scale industries, low cost housing etc., where market
has failed to deliver. BB has already taken a decision to introduce a refinancing
scheme for housing loans for lower and middle income groups. This step will provide
impetus to the housing sector which provides employment to a large number of
people. In order to boost credit in the agricultural sector, BB requested the
commercial banks (which hitherto did not provide much agricultural credit) to come
forward, and in response to that these banks have assured to provide more than Tk.
1,000 crore as agricultural credit during next 12 months.

32

Monetary policy of Bangladesh

MGT-301

After strengthening the regulatory framework, improving the bank supervision

process, and completing procedure for selling Rupali Bank, BB is now focused on
corporatizing and restructuring the nationalized commercial banks (NCBs). The
process of corporatization of three NCBs Sonali, Janata and Agrani has started.
Meantime, these banks have been turned into public limited companies. NCB reforms
will increase efficiency of financial system which in turn will enhance its resilience
contributing to firm up the monetary stability.
Monetary Stance for FY08: Keeping in view the prevailing price situation and
enhanced excess liquidity emanating from moderating private sector credit demand
and increase in net foreign assets, BBs monetary stance will continue to be cautious
in FY08. Despite persuasion of a cautious policy, growth in both money supply
(estimated) and reserve money has exceeded the program levels at the end of June
2007. In this backdrop, further review of policy interest rates may be necessary. Since
the bond/bill market is not yet developed to reduce the inflationary expectation in the
longer term, interest rate of the instruments of the shorter tenor may have to be
revisited relative to that of longer term. SLR/CRR of banks including Islamic ones
have remained unchanged since 2005. In view of the unfolding price developments
BB may review these rates. Above all, coordination among monetary, fiscal and trade
policies is required to help curb rising inflationary pressure and achieving 7.0 percent
economic growth in FY08. As before, the private sector will receive necessary policy
attention to ensure desired level of economic growth.
Apart from monetary policy stance, BB is of the opinion that the following issues to
be kept in perspective for overall economic development of the country: (a) fiscal
discipline should be adhered to by the government as strictly as possible, (b) the
spread between rate of interest on deposits and that on lending charged by the banks
should be reduced to help private sector enterprises, (c) heterodox policies to improve
production and marketing of agricultural products should be considered by the
government, (d) introduction of international prudential norms for banks and financial
institutions to be calibrated for consistency with the objective of greater financial
inclusion.
33

Monetary policy of Bangladesh

MGT-301

Bibliography:
1. www.google.com
2. www.bangladeshbank.org
3. www.banglapedia.com
4. www.thenewnation.com
5. www.financialexpress-bd .com
6. www.thedailystar.net
7. www.newagebd.com
8. www.bdnews24.com
9. www.weekipedia.org
10. www.tutor2u.net
11. www.yahoo.com

34