Monetary Policy Of Bangladesh

REPORT ON Monetary Policy of Bangladesh

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

Monetary Policy of Bangladesh

SUBMITTED TO

M. Kazi Tamim Rahman Lecturer Department of Agricultural Economics and Rural Sociology Faculty of Business Administration and Management

SUBMITTED BY Group: 01(Warrior) Level-3, Semester-1 Faculty of Business Administration and Management

Name of the students

Reg. No.

Roll No.

Md. Kamruzzaman (L)

00660

01

Shuvradeb Barai

00668

09

Abu Zafour

00680

21

Sahana Parveen

00666

07

Nazmul Alam Siddiqui

00565

25

Money and Banking Course code: FBK 312 SUBMISSION DATE:

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

Acknowledgement

At first we desire to express our deepest sense of gratitude of almighty Allah. With profound regard we gratefully acknowledge our respected course teacher M. Kazi Tamim Rahman, Lecturer, Department of Agricultural Economics and Rural Sociology, Faculty of Business Administration and Management, for his generous help and day to day suggestion during the preparation of this report. We like to give thanks especially to our friends and many individuals, for their enthusiastic encouragements and helps during the preparation of this report us by sharing ideas regarding this subject and for their assistance in typing and proof reading this manuscript.

Table of Contents

1. Introduction …………………………………………………………..…………………….. 01 ►1.1 Objective of the Study ………………………………………………………………. 02 ►1.2 Importance of the Study ……….………………………………………………...…... 02 ►1.3 Bangladesh Economy …………………………………………………………….….. 03 ►1.4 Condition of Investment Sector on Bangladesh Economy ……………………….…. 04 ►1.5 Condition of Industry Sector on Bangladesh Economy.………………………….….. 04 ►1.6 Condition of Textile Sector on Bangladesh Economy …………...………………….. 05

►2.1 Monetary Policy …………………………………………………………...………… 06 ►2.2 The Importance of Monetary Rule ………….……………………………………….. 07 ►2.3 Objectives of Monetary Policy ………………………………………………………. 08 ►2.4 Strategy of Monetary Policy ………………………………..……………………….. 12 ►2.5 Instruments of Monetary Policy …………...………………………………………… 12 ►2.6 Major Instruments Use by Bangladesh Bank ...……………………………………… 17 ►2.7 Frameworks of Bangladesh’s Monetary Policy ……………..………………………. 18 ●2.7.1 The Policy Target(s) ……………………………...…………………………... 18 ●2.7.2 Conducting of monetary policies ……………………………………….…….. 21

►Review

►

of Literature ………………………………..……………………………………. 22

Methodology of the Study ………………………………………………………………. 23

►5.1 Bangladesh’s Monetary Policy …………………………………………………….... 24

►6.1 MONETARY POLICY STANCE, JULY-DECEMBER 2007 ● 6.1.1 A Brief Review …………………………………………..……………….….. 27 ● 6.1.2 Recent Global, Development …………...…………………………………… 28 ● 6.1.3 Recent Macroeconomic Development ……….…………………….………… 29 ● 6.1.4 Recent Inflationary Trends and FY08 Outlook ………………….…..………. 31 ● 6.1.5 Recent External Sector Developments …………………………….………… 33 ● 6.1.6 Fiscal Sector Developments …………..………………………….………….. 34 ● 6.1.7 Recent Monetary Developments ……………………………….……………. 36 ►6.2 MONETARY POLICY STANCE, JANUARY-JUNE 2008 ……………………..… 38 ►6.3 Limitation of Monetary Policy in Developing Country ………………………..……. 41

► Conclusion ………………………………………………………………………………. 42 ► References ………………………………………………………………………………. 43 ► Glossary…………………………………………………… …………………………… x

CHAPTERI

INTRODUCTION 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. With the shifts of the policy stance of the government in various phases, necessary adjustments were made in the country's monetary policy. The   Department   of  Research   in  the  Bangladesh  Bank  plays an important role in  the formulation  of  economic policies of the country.  The principal function of the Department is to help the bank in the formulation of  monetary and credit policies and also to assist it in discharging its duty as adviser to  the Government on economic and financial matters. To this end, the department  keeps the top executives of the bank fully informed of latest economic development  both at home and abroad, in a regular and systematic manner. For this purpose the  Department keeps a close watch on trends in the domestic economy as well as on  international economic developments with particular reference  to  monetary,  fiscal  and trade problems and policies.  Domestic and international economic developments are brought within the compass  of  comprehensive   reports  and   reviews   which   are   submitted  for   perusal  of   the  Governor, Deputy Governor, and Senior Executives of the bank, as also the bank’s  Board of Directors.

1.1 Objective of the Study A clear objective help in preparation of well decorated report in which other take the right type of decision .So, we identifying objectives is very much important. Our objective of preparing the report is: ● To know about the Overview on Bangladesh economy ● To know about the Importance of Monetary Rules ● To know about the major Instruments Use by Bangladesh Bank ● To know about the Bangladesh’s Monetary Policy

1.2 Importance of the Study In our Money and Baking course we will only study on our text book about the monetary policy, but its basic implication in a country is practically unknown to us. So for gathering the practical knowledge about monetary policy is only then can achieve, when a practical task or report will make over it. Here our report provides information about to the monetary policy, the important rules regarding the monetary policy, the instruments of monetary policy etc. On the second part of our report contains the economy condition of Bangladesh as well as its monetary system. So this report will help us to know about the monetary policy of Bangladesh at a glance with its application.

1.3 Bangladesh Economy Bangladesh is primarily an agricultural country, with a growing industrial sector. The vast majority of its inhabitants are farmers, although few of them have actual ownership over the land that they farm. Throughout the 1980s, Bangladesh became highly dependent on foreign aid, although this brought little real change in the lives of its people. The economy of Bangladesh is the 31st largest economy in the world as measured by purchasing power parity (PPP). It has made significant strides in its economic sector since its independence in 1971. The Bangladeshi garments industry is one of the largest and most comprehensive industries in the world. Before 1980, Bangladesh's economy and foreign exchange earnings were driven by the jute industry. However, this industry started to fall dramatically from 1970, when polypropylene products gained popularity over the jute products. Current GDP per capita of Bangladesh registered a peak growth of 57% in the Seventies immediately after Independence. But this proved unsustainable and growth consequently scaled back to 29% in the Eighties and 24% in the Nineties. Bangladesh has also made major strides to meet the food needs of its increasing population, through increased domestic production. Currently, Bangladesh is the fourth largest rice producing country in the world. The land is devoted mainly to rice and jute cultivation, although wheat production has increased in recent years the country is largely self-sufficient in rice production. Nonetheless, an estimated 10% to 15% of the population faces serious nutritional risk. Bangladesh's predominantly agricultural economy depends heavily on an erratic monsoonal cycle, with periodic flooding and drought. Although improving, infrastructure to support transportation, communications, and power supply is poorly developed. The country has large reserves of natural gas and limited reserves of coal and oil. While Bangladesh's industrial base is weak, unskilled labor is inexpensive and plentiful. Overview on Bangladesh Economy ● At the time of independence, Bangladesh pursued a socialist economic policy. ● By 1977, all nationalized institutions were returned to their former owners, but this resulted in little substantial economic progress. ● Between 60% and 75% of Bangladesh's population are landless. ● Bangladesh's GNP per capita is $360. ● Despite its low GNP per capita, Bangladesh has done better in areas of human and social advancement than many other countries with similar income. 1.4 Condition of Investment Sector on Bangladesh Economy

The stock market capitalization of the Dhaka Stock Exchange in Bangladesh crossed $ 10 billion in November 2007. The earliest strategy of the Bangladeshi government was to promote industrialization by making funds available for businessmen through subsidies and national banks. But this plan went awry, as the government lacked the political will to stop financing poorly-performing companies. As a result, the national banks had built large heaps of 'non-performing' loans which are unlikely to be ever repaid. The failure of the national banks discouraged investments by the emerging private financial sector. Currently, Bangladeshi entrepreneurs generally suffer from lack of funding as many banks are reluctant to invest in industry and have instead turned their attention to consumer credit. 1.5 Condition of Industry Sector on Bangladesh Economy Fortunately for Bangladesh, many new jobs - mostly for women - have been created by the country's dynamic private ready-made garment industry, which grew at double-digit rates through most of the 1990s. By the late 1990s, about 1.5 million people, mostly women, were employed in the garments sector. During 2001-2002, export earnings from ready-made garments reached $3,125 million, representing 52% of Bangladesh's total exports. Eastern Bengal was known for its fine muslin and silk fabric before the British period. The dyes, yarn, and cloth were the envy of much of the promoter world. Bengali muslin, silk, and brocade were worn by the aristocracy of Asia and Europe. The introduction of machine-made textiles from England in the late eighteenth century spelled doom for the costly and time-consuming handloom process. Cotton growing died out in East Bengal, and the textile industry became dependent on imported yarn. Those who had earned their living in the textile industry were forced to rely more completely on farming. Only the smallest vestiges of a once-thriving cottage industry survived. At independence Bangladesh was one of the least industrially developed of the populous nations. Annual per capita consumption of steel and cement was only about one-third that of India, for example, and electric power consumption per capita was less than one-fifth.

1.6 Condition of Textile Sector on Bangladesh Economy Bangladesh's textile industry, which includes knitwear and ready-made garments along with specialized textile products, is the nation's number one export earner.

The sector, which employs 2.2 million workers, accounted for 75 per cent of Bangladesh's total exports of US$10.53 billion in FY2005-06, in the process logging a record growth rate of 24.44 per cent. However, since May of 2006 the industry has been plagued by on-going industrial unrest, as textile workers, who are among some of the most lowly paid in the world, have staged regular violent demonstrations in a bid to achieve a higher minimum wage, regular rest days and safer working conditions. Following the worst of the unrest in late May, which saw at least one worker killed as police shot live rounds at protesters, the government formed a Wage Commission, ordering it to report on a suitable new minimum wage in three months. The Commission, which included business and worker representatives, finally released its conclusions on October 9, recommending the wage be set at Tk1, 662.50, up from the current level of Tk950, but far below initial worker demands for Tk3, 000. Whether this new wage will placate workers, who allege years of unsafe and abusive conditions remains to be seen. Fresh outbreaks of violence occurred on Oct 2, 3 and 10, but at least some of these protests appear to have stemmed from factory-specific factors, rather than industry wide discontent.

CHAPTER2 Monetary Policy 2.1 Monetary Policy

Monetary policy is the term used by economists to describe ways of managing the supply of money in an economy. Monetary Policy is the management of money supply and interest rates by central bank to influence prices and employment for achieving the objectives of general economic policy. Monetary policy works through expansion or contraction of investment and consumption expenditure. According to Paul Einzig “Monetary policy includes all monetary decisions and measures irrespective of whether their aims are monetary and non-monetary, and all non-monetary decisions and measures that aim it affecting the monetary system.” According to Harry G. Johnson “Monetary policy employing the central band’s control of supply of money as an instrument for achieving the objectives of general economic policy.” According to G.K. Shaw “By monetary policy we mean any conscious action undertaken by the monetary authorities, to exchange the quantity, or cost (interest rate) of money.” From the above discussion monetary policy may be defined as the central bank’s policy pertaining to the control of the availability, cost and use of money and credit with the help of monetary measures in order to achieve specific goals.

2.2 The Importance of Monetary Rule There is a difference in between “pegged” and “fixed” rates, which lies in the adjustment system. A fixed exchange rate is the monetary rule that contains an equilibrating mechanism of the balance of payments. The gold standard was a good example of fixed rates. Countries defined their currencies in terms of weights of gold and exchange rates represented the ratios of the weights. This system got into

trouble very rarely, as during war, countries turned to finance deficit etc. Success of gold depends on fiscal prudence. A country fixes the exchange rate between its currency and an important foreign currency. A currency board works automatically to preserve equilibrium in the balance of payments. Some writers now speak of a “currency board” in order to describe a fixed exchange rate system because there is a common confusion between pegged and fixed exchange rate. A fixed exchange rate is a monetary rule that gives the country the monetary policy of the partner country. On the other hand pegged rate is an arrangement whereby the central bank intervenes in the exchange market to peg the exchange rate but still keeps an independent monetary policy. A flexible exchange rate is consistent with any monetary policy at all hyperinflation. Some countries don’t have the option of fixing the exchange rate because some countries are too small but one of the countries is too large to fix, such as United States. This is because there is no currency to fix the US dollar. In this case the only choice is inflation targeting or monetary targeting, which depends on inflation rate. Stability of the inflation rate is an important policy and low inflation rate produce more stable inflation rate. It is very important that monetary aggregates contain important information about the economy. So from all of these discussion we see that how monetary rules affect the economy and its importance in fixing the exchange rate.

2.3 Objectives of Monetary Policy Monetary policy aims and methods have changed over time. Both in developed and developing economies, monetary policies seek to maintain price stability by sustained stable output growth in the face of internal and external shocks that are faced from time to time.

In developed economies with production factors at or close to full employment, monetary policies are formulated typically with the output gap (difference between the actual and the longer run potential output) in view; the policy stance is eased to provide stimulus at times of slowdown when actual output lags the longer run potential, and the stance is tightened to slow things down when the economy overheats with actual output running ahead of the sustainable longer run potential. Diagnosing and treating asset price bubbles symptomatic of overheating are major issues of current debate in monetary policy. For developing economies like Bangladesh with significant underemployment/ under exploitation of production factors, stimulating higher growth is imperative for rapid reduction and eventual elimination of endemic poverty, and is therefore an overriding priority. The stimulus provided by monetary policies in accommodating the growth aspirations must not however over step towards macroeconomic imbalance destabilizing and jeopardizing future growth; and the pursuit of monetary policies comprise the continual balancing act of supporting the highest sustainable output growth while adjusting smoothly to internal and external shocks that the economy encounter from time to time. The primary objective of the Monetary Policy of Bangladesh is to outline the formulation and implementation of monetary policy of the Bangladesh Bank (BB), and to convey its assessment of the recent and the expected monetary and inflation developments to the stakeholders and the public at large. The Bangladesh Bank Order of 1972 outlines the main objectives of monetary policy in Bangladesh, which comprises— ■ To achieve the price stability ■ To regulate currency and reserves ■ To promote and maintain a high level of production, employment and real income, and economic growth, since independence BB operated under a variety of pegged exchange rate systems amid capital controls ■ To manage the monetary and credit system ■ To maintain the par value of domestic currency ■ To promote 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. In effect, the exchange rate served as a nominal anchor, with the ultimate goal of maintaining price stability. However, prices of non-tradable goods, given the latter’s high share in national expenditure, dominated the inflation behavior. Indeed the prevailing exchange rate during the 1970s and 80s remained mostly overvalued which was also accompanied by high (typically double digit) inflation

The Broad Discussion of Monetary Policy Objective ►Price stability Inflation distorts economic calculations and expectations while deflation creates depression in the economy. Thus price stability should be the main aim of monetary policy. Price stability promotes business confidence, makes economic calculation possible, controls business cycle and introduces certainty in economic life. Be that as it ma, it must be admitted that price stability does not be necessarily mean absolute constancy of price level. A very slow rising price level (or mild inflation) may have all the virtues of a stable price level, which can contribute more directly to economic growth. ► Exchange Stability Maintenance of stable exchange rates is an essential condition for the creation of international confidence and promotion of smooth international trade on the largest scale possible. A restrictive monetary policy trends to reduce a country’s balance of payment defect in the following ways: ● It tends to reduce demanding the country, which in turn tends to reduce the demand for imports as well as for domestic goods. ● Reduction in domestic demeans holds down the rate of inflation or reduces prices which makes imported articles less attractive and makes the defect country’s exports more attractive to foreigners. Thus, import is curtailed and export expanded.

● Under dear money policy, higher interest rates make it less attractive for foreign countries to borrow from the defect country and induce them to invest there. ► Full Employment In under developed countries, the full employment objective is more crucial, because such economies have both unemployment and under employment open and disguised. In less developed countries, though full employment cannot be achieved within a short period, the monetary policy should try to achieve at least a near full employment situation. Full employment objective of monetary policy has certain far-reaching beneficial effects: ● Full employment can maintain a high level of aggregate effective demand, and thereby can iron out cyclical fluctuations, stagnation and under consumption trap. ● Before full employment is achieved, investment can be made in excess of saving and a price increase in a slow rate is permissible. These will give incentive for the fuller utilization of resources and for higher income, output and employment. ● The creation of full employment condition will almost automatically, lead to the maximization of social and economic welfare of the society because the resources would be used fully and effectively. ● Full employment will, according to Einzig, lead to increase productivity of workers, because the workers are not sacred of unemployed situation. The relation between labor and capital would be ideal and all-round efficiency will increase.

► Economic Growth This comparatively a recent object of monetary policy. If refers to the growth of real income or output per capita. Monetary policy can contribute to economic growth in the following ways: ● It can maintain a balance between monetary demand and supply of goods, and it can also supply money is such a way as is consistent with the supply of goods and services.

● It can create atmosphere in which a higher rate of saving and investment would be generated. ● Monetary policy minimizes fluctuation in business activity and prices. ● It creates stability for growth. ● It influences the rate of interest, investment and the use of credit in the most productive channels in the economy. ● When necessary, it expands credit and when it is not necessary, if restricts the flow of credit. It creates saving intuitions and monetization in the saving of the community towards productive investment. ● Monetary policy gives guidance, looks after monetization in the unorganized sector and controls the actives of the financial intermediaries. ► Neutrality of Money Neutrality of money indicates a situation in which changes in the quantity of money occurs in such a way as to cause a proportionate change in the equilibrium prices of commodities, and the equilibrium rate of interest remains unchanged. If money is neutral, an increase or decrease in the quantity of money will both produce and disturbing effects in the economy. Neutrality of money does not mean constant money supply, means that the effect of changed money supply on real variables in the economy would be neutral. ► Balance of Payment Equilibrium Balance of payment equilibrium condition is a position at which a country repaid its debts and has attained an adequate reserve at zero balance over time. This main objective on monetary policy has become significant in the pose-period. It is realized that the existence of balance of payment deficit seriously reduces the ability of an economy to attain other objectives. So, monetary policy must make into consideration the international payment problem. 2.4 Strategy of Monetary Policy The MPS (Monetary Policy Statement) starts with expression of the monetary policy frameworks in terms of the goals, instruments, and the channels of transmission. Maintaining price stability while supporting the highest sustainable output growth is the stated objective of monetary policies pursued by the Bangladesh Bank.

2.5 Instruments of Monetary Policy 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. Although, the fixation of target continued to remain as the central piece of exercise, the way to achieve it had been changed. Credit ceilings on individual banks and direct controls of interest rates were withdrawn. At present, the money supply is regulated through indirect manipulation of reserve money instead of credit ceiling. Major instruments of monetary control available with Bangladesh Bank are the bank rate, open market operations, rediscount policy, and statutory reserve requirement. The methods of credit control can be classified as follows: a. Quantitative/ General Methods: 01. Bank rate policy 02. Open market policy 03. Variation of reserve ratio b. Qualitative/ General Methods: 01. Rationing of credit 02. Direct action 03. Regulation of consumers’ credit 04. Moral persuasion 05. Publicity

The methods of credit control are described below: a. Quantitative/ General Methods: The methods by which Central Bank controls the total amount of credit in the economy are termed as quantitative methods of credit control. 01. Bank rate policy

The rate which central bank lends money to the commercial banks and discounts bill of exchange is called bank rate. If central bank increases the bank rate then the commercial banks will increase their marker of interest rates. As a result the borrowers borrow less form commercial banks and amount of credit reduces in the economy. In an opposite way amount of credit will be increased in the country. Effects Effects on price level If bank rate increases, cost of credit will increase and the businessmen will reduce their borrowing s form commercial banks. This will reduce production and increase unemployment in the economy. As a result, income and price level will go down and depression in business and trade will be the outcome. If there is a decrease in the bank rate the opposite e results of above will be experienced in the economy. Effects on foreign trades An increase in bank rate wills increases other interest rates in the country. So, investment will be profitable. It will ensure the insertion of foreign capital into the economy and leakage of domestic capital will be stopped. Moreover, increased bank rate will decrease the piece level because amount of credit will be reduced into country. This decreased price level will again encourage expert and discourage import, which will make balance of payment favorable. Opposite effects of above will be experienced if the central bank decreases the bank rate in the economy. Limitations of Bank rate policy ●bank rate policy would not be effective if there lacks strong linkage between bank rate and market/ interest rate especially for a developing country like Bangladesh. ● If commercial banks have excessive money then bank rate may not be effective because they will lend in lower interest rates though bank rate increases.

●bank may successes during the time of prosperity. Because businessmen become highly ambitious of their profits in this situation and will borrow money though the interest rate increases. ● Reduction in bank rate may not be successful to increase the amount of credit during the time of depression. So, bank rate policy has several limitations in its operation. After that it is the best weapon of central bank to control the amount of credit in the economy.

02. Open market policy The method by which the central bank controls the amount of credit by selling and buying government credit instrument is termed as open market operation. When the central bank intends to contract credit, it sales the credit instruments in the market. These instruments are purchased by commercial banks and people also buy them issuing cheques to the commercial banks. Thus money goes to the central bank and amount of money for credit creation reduces which in turn contracts the amount of credit in the economy. Limitations of open market policy ● Selling- it reduces amount of cash of commercial banks .but if commercial banks take loan form central bank it would not be effective to reduce credit. ● Buying- it increases the amount of cash in commercial banks. But it may not be able to expand credit if commercial banks repay loan to the central bank with this increased cash. ● Depreciation- During depreciation credit expansion through purchasing credit instruments is not possible. Because in this period businessmen will not want to borrow from commercial bank. 03. Variation of reserve ratio Each commercial bank has to keep legally a certain portion of its total deposits as reserve with central bank. This is called reserve ratio. If central bank increases this reserve ratio, excess reserve in commercial banks will reduce and thus credit creation will be contracted in the economy. In an opposite way central bank can increase the amount of credit by decreasing the reserve ratio. Limitations ● Increase in reserve ration can be effective for that commercial bank having small amount of cash. Because bank having large volume of cash will have sufficient excess reserve to create credit though reserve ration increases. In this case it will not be effective.

● Decrease in reserve ration may not be effective to expand credit during depression as businessmen are discouraged to borrow in this situation. ● Non-scheduled commercial banks are out of this control. b. Qualitative/ General Methods The methods used to control credit in special sectors for special purposes are called qualitative\selective methods of credit control. These methods do not deal with the amount of credit rather change the flow or direction of credit used in different sectors of economy. 01. Rationing of credit Rationing of credit means fixing the amount of credit among different sectors of the economy. By this method central bank can decrease the amount of credit in one sector and can increase it in other sector. For example, if central bank thinks that there is excessive investment in garments industry and jute industry suffers form required investment, then it can order the commercial banks not to disburse credit beyond required amount in garments industry and divert the excess amount to jute industry. Limitations ● Borrowers may use the credit money in other purposes. ● It is difficult for central bank to supervise whether the credit money is being used purposively or not. ● Sometimes commercial banks think this type of work as an unwanted intervention by central bank.

02. Direct action If it is proved by central bank that credit creation policy of any commercial bank is not transparent then central bank can take punitive measures against that bank and thus affects its credit creation. These punitive measures may be of not rediscounting bills of exchange, discounting bills of exchange at a rate higher than the prevailing

rare, etc. As a result, the commercial bank will compelled to follow sound central bank policy. 03. Regulation of consumers’ credit It is a method to control credit in consumable goods, which are purchased in installment basis. If central bank circulates to increase the amount of down payment or reduce the number of installment then consumer’ credit will be contracted in the economy. In an opposite way consumers’ credit can be increased. It was followed in USA during Korean War. 04. Moral persuasion To make the banking system sound and efficient, central bank sometimes requests the commercial banks to increase or decrease credit. As a guardian’s request, commercial banks follow it and thus amount of credit is controlled in the economy. 05. Publicity Sometimes central bank applies publicity as a weapon of credit control. Central bank publishes weekly, fortnightly or monthly bulletins and annual reports where balance sheets and other business and economic condition of different commercial banks are presented well. As a result the commercial banks become more careful in the line of their credit creation. Thus central bank applies various types of measures to control credit in the economy. But central bank should apply different types of method simultaneously rather to use single method to make credit control effective.

2.6 Major Instruments Use by Bangladesh Bank 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 re fixation of the rates of deposits and advances. Moreover, the existence of 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 and for projects of Bangladesh Rural Development Board financed by SONALI BANK. 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. 2.7 Frameworks of Bangladesh’s Monetary Policy

2.7.1 The Policy Target(s) In this backdrop it is necessary that the monetary policy framework (in terms of the goals, the instruments, and the analytic channels of transmission) be articulated for greater clarity and transparency benefiting both the policy makers as well as the stakeholders. A policy system, where the goals are transparent and their achievement verifiable, directly adds to the credibility of the central bank, a major objective of this document is to define such a framework. Most industrial economy monetary policy is run with the task of keeping watch on both the output gap (i.e., the deviation of actual output from its long-run equilibrium level) and the inflation gap, which is similarly defined. In contrast, however, the challenge in the developing world is how to augment the capacity output through both productivity growths as well as via the installation of additional capacity. Faster growth in most developing contexts is necessary to reduce (and eventually eliminate) common poverty. Hence the appropriate monetary policy strategy in the Bangladesh context would be to achieve the goal of price stability with the highest sustainable output growth. Any monetary stimulus to promote growth must keep in perspective the broader goal of macroeconomic stability, which is a prerequisite for future growth. Price stability would also include the stability of the currency regime. While fiscal policy too is relevant in addressing these goals and thus there is a need for policy coordination, monetary policy must play its due role. While leading central banks in the industrial world have increasingly adopted the unitary goal of fighting inflation, interestingly directive by enumerating (a) The promotion of price stability, (b) Ensuring full employment, (c) Supporting global economic and financial stability (so long as the latter may be targeted without prejudicing the first two goals) as the chief monetary policy goals. In broad terms therefore the latter view is consistent with the BB vision as enunciated above, although anchored along different perspectives.

Inflation Target It is the general wisdom that monetary policy tools are of immediate influence in controlling inflation. However contemporary evidence amply illustrates that monetary policy cannot deal well with the inflationary impact of external shocks such as the recent international price of oil and related energy products. Many central banks as a consequence focus on the core inflation, which is typically constructed by subtracting the most volatile components (e.g., food and energy prices, indirect taxes etc) from the consumer price index (CPI). The Bank of Canada argues that it is the core concept that better predicts the underlying price stability in the economy. Hence as a policy goal, core inflation may be a more credible target than CPI inflation. While there is no standard measure of core inflation in the Bangladesh context at this time, the construction methodology is made complex by two facts. First is that food items constitute nearly 60 percent of the CPI index, and while the appropriate commodity group weights may require a re-think, to ignore food entirely in defining the core inflation may render the construction a bit like ‘throwing the baby away with the bath water. Secondly, in the Bangladesh context, the volatility of the international energy prices appear not to filter down to the CPI since the relevant domestic prices are subsidized by the state. Periodic adjustments in administered energy prices have always lagged the world market changes in both the time line as well as in magnitude often most dramatically. While it may be useful to focus on the non-food component of the index (which occupies only 41.6 percent of the full CPI) in order to gauge at the build-up of underlying inflationary forces in the economy, it would be unwise to treat this alone as a valid measure of core inflation. Growth target GDP growth projections of the Medium Term Macroeconomic Framework (MTMF) in the government's National Strategy for Accelerated Poverty Reduction (NSAPR), modified appropriately in the light of unfolding actual developments, are used as output growth targets for the purpose of monetary policies. The MTMF projected 6.5 percent and 6.8 percent real GDP growth for FY06 and FY07 respectively. In view of the good post flood recovery of agricultural output and the better than expected holding up of apparels export demand after MFA expiry, real GDP growth targets for the purpose of monetary policies have been taken as 6.8 percent and 7.0 percent respectively for FY06 and FY07. Unavailability of intra year GDP growth

estimates is a constraint in appropriate ongoing revision of monetary and other macroeconomic policies in the context of unfolding economic realities. Strengthening the capabilities of BBS towards regular estimation and release of reliable quarterly GDP data has therefore assumed priority. Updated assessment GDP growth remained robust at an estimated 6.5% in FY2007, propelled by rising domestic and external demand. A strong expansion in industry (9.5%) and continued buoyancy in services (6.7%) largely offset agriculture’s moderation following its post flood bounce back of the preceding year (Figure 3.1.1). Industry was sustained by strength in manufacturing (up 11.2%), in turn driven by continued growth in external demand for garments. The manufacturing and trade performance sustained steady expansion in services. On the expenditure side, growth was underpinned by private consumption. Private investment, aided by growth in bank credit and workers’ remittances, also contributed to sustaining economic expansion. But total investment, at 24.3% of GDP in FY2007, declined by 0.4 percentage points compared with the preceding year, on moderation in public investment following downsizing of the annual development program. Net exports of goods and services were a slightly negative factor that subtracted from growth, though by less than in the previous year. Inflation continued to creep up, to 9.2% in June 2007 on a year-on year basis, with increases in both food and nonfood prices (Figure 3.1.2). Rising domestic demand pressures, stemming from a steady expansion of income, a large increase in workers’ remittances from abroad, and high monetary growth heightened inflationary pressures, as did a further rise in international food and commodity prices. Imported fuel has only a limited impact given its small weight (4%) in the index and low energy intensity of production. The Government’s recent administrative measures to counter inflation, such as investigations of certain businesses suspected of hoarding supplies; measures to regulate stock levels and prices; as well as its encouragement to new importers to enter the market and so induce greater competition, appear to have had no discernible impact on inflation. They have, rather, created uncertainty in the business environment, contributing to price pressures. 2.7.2 Conducting of monetary policies

As mentioned in the foregoing, the near term inflation objective of monetary policies will be to contain the annual average CPI inflation, on an upswing phase since 2001, at around the current level under 7.0 percent. Monetary policies will therefore be on tightened stance until inflation levels off and enters its downswing phase.

CHAPTER3 Review of Literature Election 2001: National Policy ForumDhaka: 20-22 August, 200,1Organized by: Centre for Policy Dialogue, Prothom Alo, The Daily Star, Policy brief on “Monetary Policies” The objective of the Policy Brief exercise is to articulate a concrete policy agenda, with strong emphasis on its implement ability. The point of departure of the present Policy Brief is the premise that a sound and stable macroeconomic framework is a fundamental pre-requisite for sustained high growth. In this connection, the prime objective of the present Policy Brief is two fold: (a) to

identify the pressing issues in the areas of public finance and (b) to suggest remedies, improvements and policy changes in this regard. Election 2001: National Policy Forum, Dhaka: 20-22 August, 2001Organized by: Centre for Policy Dialogue, Prothom Alo, The Daily Star, POLICY BRIEF ON "IMPACT OF MONETARY POLICY ON INDUSTRY AND TRADE" The objectives of this Policy Brief on Industry and Trade, inter alia, include the following: To highlight important milestones in the development of Bangladesh's industry and trade sectors over the recent past, to articulate major challenges in the area of industry and trade, to come up with policy recommendations to address the attendant challenges, to provide inputs to the electoral discourse on issues related to development of industry and trade in Bangladesh, and Based on the above, to put before the newly elected government a set of actionable agendas to stimulate development of trade and industry. PRO-POOR FISCAL AND MONETARY POLICIES: TOWARDS CORRECTING STRUCTURAL INJUSTICEIN SOUTH ASIA, Rehman Sobhan, September 2002, [email protected]; Website: www.cpd-bangladesh.org.

The Inflation Debate by Syed A. Basher and Sharif Faisal Khan, this report is showing the impact of the rise in the inflation rate higher in Bangladesh Economy Policy. A. Begum and M. Salimullah 2004, Millennium Development Goals Needs Assessment:Bangladesh Country Study, Working Draft, 17 January 2004, Bangladesh Institute of Development Studies, Dhaka

CHAPTER4 Methodology of the Study This report on Monetary Policy of Bangladesh is based on both primary and secondary data. Initially, the work is started with data those were available in different books of Bangladesh economy as well as journal, magazine, newspapers etc. Moreover, we becomes gather some more information from the different websites.

Then we accumulate all the data and summarize them and then we analyze those data from many angles, in different aspect and present the information in different segment according to their category, in compact way. We highlight different important things, which we found during our survey. After doing all of those we submit the report to the proper authority.

CHAPTER5 MONETARY POLICY OF BANGLADESH 5.1 Bangladesh’s Monetary Policy In the first years after liberation, the primary target of monetary policy of Bangladesh was to regulate not the quantity of money, but the direction of the flow of money and credit in support of the government financial programmed. In 1975, Bangladesh entered into a standby-arrangement with 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) i.e., 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. The Bangladesh Bank (BB) has been announcing its monetary policy stance on a biannual basis through the Monetary Policy Statement (MPS) since January 2006. Objectives of the monetary policies of the Bangladesh Bank as outlined in the Bangladesh Bank Order, 1972 comprise attaining and maintaining of price stability, high levels of production, employment and economic growth. The policy stances envisage repo, reverse repo, and BB bill rates as the routinely employed policy instruments for influencing financial and real sector prices towards the targeted path of inflation.

The annual monetary programmes adopt the reserve money (RM) and broad money (M2) as intermediate targets; supported by a framework for regular tracking of other asset and liability side sub-aggregates. The present MPS provides the monetary policy stance that BB intends to follow during the second half: January to June (H2) of FY08. The prime objective of the policy stance for H2 FY08 is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal, and monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of FY08. Note Issuing Process

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. Bangladesh use minimum reserve system for issuing note in the country. Under this system, the central bank has to keep a minimum reserve of gold against the issue of notes. The bank can also issue notes up to any extent necessary; no minimum limit of note is fixed.

These coins are currently circulating in Bangladesh as money. The monetary system of Bangladesh is decimal based, with the primary unit of Bangladeshi money being called the Taka. The names and relative values of the coins depicted above are, from left to right: ■ One Poisha - 1/100 of a Taka ■ Five Poisha - 5/100 of a Taka ■ Ten Poisha - 10/100 of a Taka ■ Twenty-Five Poisha - 25/100 of a Taka ■ ifty Poisha - 50/100 of a Taka ■ One Taka - 100/100, 1 full Taka ■ Five Taka - 500/100, 5 full Taka **Please note that this listing only includes the coins in circulation. There will be paper money circulating as well.

CHAPTER6 MONETARY POLICY STANCE, JULY-DECEMBER 2007 AND JANUARYJUNE 2008 6.1 MONETARY POLICY STANCE, JULY-DECEMBER 2007 6.1.1 A BRIEF REVIEW The monetary policy stance for Bangladesh for the first half (H1) of FY08 was announced through the MPS in July 2007. Keeping in view the BB’s overall objective of supporting the highest sustainable output growth along with maintaining price stability, the MPS for H1 FY08 reiterated its intention to follow a monetary policy primarily to arrest the uptrend in inflationary tendency and reduce inflation expectations. The monetary policy stance for H1 FY08 was designed around a projected real GDP growth rate of 7.0 percent and an annual average CPI inflation within a range of 6.5 percent to 7.0 percent during FY08.

The MPS mentioned that BB would regularly review its policy rates and SLR/CRR of banks in order to ensure consistency with unfolding price developments. The major emphasis of the policy stance was on providing necessary support towards achieving the desired rate of economic growth. Over the last six months, the policy stance announced in July 2007 was moderated in the wake of several unexpected domestic shocks and unfavorable international developments that brought about significant changes in the macroeconomic scenario. The domestic production, especially in the agriculture sector, was severely affected by two consecutive floods and a devastating cyclone along with extensive loss and damage to human lives, infrastructure, and other assets that would require some time to repair and reconstruct as well as significant financial and other resources. At the international level, the prices of most of the commodities including oil that Bangladesh imports have witnessed unprecedented rise creating significant upward pressure on domestic prices leading to increase in the inflation rate beyond the targeted level. In the backdrop of the above developments, the monetary policy stance for H1 FY08 faced the following key challenges: Strong inflationary pressure emanating from both domestic and external sources that led the CPI inflation to overshoot the targeted range of 6.5 percent to 7.0 percent for FY08; • Low level of investment and overall economic activity resulting from natural disasters and shaken business confidence; • Lagged effects of higher than programmed monetary expansion during FY07 and earlier years; • Excess liquidity and relatively high spread between deposit and lending rates in the banking sector; • Emergence of current account deficit resulting from widened trade deficit despite a healthy growth in workers’ remittances; • Disruption in normal economic activity, especially in the agriculture sector and the rural economy, due to two consecutive floods and a devastating cyclone and the urgent need to undertake relief and rehabilitation efforts. The MPS for H2 FY08, therefore, makes appropriate adjustments in the monetary policy stance using revised growth and inflation projections in the backdrop of recent domestic and global developments, as presented below, and their likely outcomes during the remaining period of FY08.

6.1.2 RECENT GLOBAL DEVELOPMENTS After achieving a robust growth of 5.4 percent in 2006, the global economy is projected to grow by 5.2 percent in 2007 and 4.8 percent in 2008 (IMF, WEO, October (2007). On the other hand, the developing world is likely to grow by 8.1 percent in 2007 and 7.4 percent in 2008. This positive outlook, however, is subject to significant risks, such as higher oil prices, volatile exchange rates in the major economies, higher global food inflation, dullness in the housing market in major economies especially in the US, significant pressure on global inflation, and a slower growth outlook for Japan and the Euro area. Prior to these recent turbulences, central banks around the world were generally moving towards tight monetary policy to face the challenge of maintaining non inflationary growth. However, in view of the potential adverse impact of tightened credit condition in restraining economic growth, the Federal Reserve Bank of the US reduced the federal fund rate while the Bank of Japan and European Central Bank kept their policy rates unchanged at early 2007 levels. On the other hand, the Bank of England continued to follow the tightened policy. The reaction among the emerging market economies was mixed; while some central banks eased the monetary policy, others tightened it further. 6.1.3 RECENT MACROECONOMIC DEVELOPMENTS Growth Outlook for FY08 The objective of BB’s monetary policy is to support maximum sustainable growth along with macroeconomic stability in general, price stability in particular, such that Bangladesh can become a member of the ‘middle income group country’ by the end of the next decade. The country’s real GDP has been growing at an annual average rate of more than 6 percent over the last five years. Although the MPS of H1 FY08 used a projected GDP growth rate of 7.0 percent for FY08, recent domestic and international developments including recurrent floods, devastating cyclone (Sidr), temporary disruption in domestic supply, and persistent price hike of essential commodities in the international market have adversely affected the economy’s growth prospects requiring a downward adjustment in the projected GDP growth rate for FY08.

BB has, therefore, revised the GDP growth rate downward to lie in the range of 6.0 percent to 6.2 percent from the recent projection of the Policy Analysis Unit (PAU) of BB for FY08. According to the projections, the agriculture sector is likely to grow at a rate lying between 2.3 percent and 2.5 percent in FY08 compared with the growth of 3.2 percent in FY07. However, it is possible to achieve even a higher growth in agriculture through recouping the losses especially to the aman crop and other agricultural sub-sectors due to consecutive floods during July-September 2007 and the devastating cyclone in mid-November 2007, through significantly increasing crop production during the boro season (boro rice contributes more than 55 percent of the country’s total rice production) and rapidly implementing rehabilitation measures in other subsectors. BB has taken steps to ensure timely disbursement of adequate agricultural credit and this needs to be supported by measures by the government to ensure adequate supply of agriculture inputs (such as, fertilizer, power, diesel, and good quality seeds) through streamlining the input distribution system. A comprehensive rehabilitation programme is also necessary in the cyclone affected areas.

FY 05

FY 06

FY 07

Oct. 07

CPI

6.49

7.16

7.20

8.25

Food

7.90

7.76

8.11

9.29

Non-food

4.33

6.40

5.90

6.72

CPI

7.35

7.54

9.20

10.06

Food

8.73

8.81

9.82

11.73

Non-food

5.32

5.73

8.34

7.42

Real GDP

5.96

6.63

6.51

--

Agriculture

2.20

4.94

3.18

--

Industry

8.28

9.74

9.51

--

Services

6.40

6.40

6.74

--

Average inflation

Point-to-point inflation

Economic growth

Table 1: Selected Economic Indicators

BB projects the industry sector growth to lie between 8.5 percent and 8.7 percent in FY08 which was 9.5 percent in FY07. In recent years, growth in the industry sector has been driven by the export oriented manufacturing sector. Although export earnings declined by 5.4 percent in the first quarter of FY08 due mainly to a decline in export of readymade garments, the situation has improved since then and the export earning is likely to rebound soon. The projections suggest that industry sector growth in FY08 is likely to be driven by large scale manufacturing industries growth between 8.7 percent and 8.9 percent and a robust growth between 10.9 percent and 11.1 percent for SMEs facilitated by the focused support programmes adopted by the government and the BB. The construction sector, which experienced a relatively slow growth in FY07, is expected to benefit from the strong growth in remittances and BB’s refinance programmed for housing at a lower rate. Based on year-on-year basis, the growth of credit to the private sector at the end of October 2007 was 16.3 percent as against 15.1 percent at the end of June 2007 indicating a rebound in the industrial growth potential in FY08. The services sector is expected to grow at a rate between 6.1 percent and 6.3 percent compared with 6.7 percent in FY07.

GDP, in FY2008. To facilitate the Corporation’s operations, the Government is assuming its overdue bank loans (contracted largely to cover past losses). These will be financed through a $1.1 billion bond to be issued in FY2008, which would provide the banks with an earning asset. However, to avoid re-accumulation of losses at BPC and of nonperforming loans (NPLs) at the four nationalized commercial banks (NCBs), the Government needs to quickly introduce an automatic price adjustment mechanism and improve the Corporation’s operating efficiency. The losses of the Bangladesh Power Development Board should also fall, because the electricity tariff to the distribution companies was raised by 10% in March

2007. However, these companies may pass on only a 5% increase to urban consumers. But switching over to a cost-reflective tariff structure for generation would be more desirable as the annual loss of the Board, even at new tariffs, is estimated at $200 million in FY2007. 6.1.4 Recent Inflationary Trends and FY08 Outlook The FY07 ended with a CPI inflation rate of 7.2 percent in June 2007 that exceeded the FY07 target of 7.0 percent. The strong inflationary pressure inherited from FY07 along with adverse changes in prospects for domestic production (mainly due to floods and cyclone) and the persistently rising prices in the international commodity market led to a steady rise in the inflation rate since the beginning of FY08. It picked up to 8.25 percent in October 2007 overshooting the July 2007 MPS projection of the average inflation rate between 6.5 percent and 7.0 percent for FY08. On point-to-point (p-t-p) basis, the rise in the inflation rate was higher; it went up from 9.20 percent in June 2007 to 10.12 percent in August 2007 and slightly moderated to 10.06 percent in October 2007. The rise in the inflation rate in H1 FY08 can be attributed more to supply constraints caused by both external and internal shocks, while the demand factors remained mostly subdued as evidenced from the existence of huge excess liquidity in the banking system. This has been mainly due to deceleration in economic activities following natural calamities, reform measures, and administrative drives against corruption and tax evasion. Moreover, Bangladesh being an importdependent country, the economy remains highly susceptive to price changes in international commodity markets especially that of food items. In the international market, the prices of fuel items increased at rates between 24 percent and 45 percent and that of food items rose by between 5 percent and 67 percent over the year ending in September 2007. The international commodity price index, which includes both fuel and non-fuel price indexes, increased by around 61 percent in September 2007 over the preceding one year, largely dominated by resurgence of oil and food prices. Among the food items, prices of edible oil and wheat increased the most, both by an unprecedented 68 percent during the period. Since the weight of food items in total CPI and imports is relatively high in Bangladesh, increase in food prices in the international market puts a significant pressure on the cost of living in direct and indirect ways.

In recent months, the inflation rate for most of our trade partners and countries in the region has shown upward trend. The headline inflation was 2.8 percent in the US and 2.1 percent in the Euro area in September 2007 as compared with 2.7 percent and 1.9 percent respectively in June 2007. Amongst our Asian trade partners, consumer price inflation in China, Thailand, and Indonesia increased to 6.2 percent, 2.1 percent, and 7.0 percent respectively in September 2007 from 4.5 percent, 2.0 percent, and 6.3 percent in June 2007. The consumer price inflation in India stood at 6.6 percent in October 2007 as compared with 5.7 percent in June 2007. The inflation rate (on point-to point basis) in Pakistan and Sri Lanka also went up to 9.3 percent and 19.6 percent respectively in October 2007 from 7.0 percent and 13.0 percent in June 2007. Nevertheless, the developments in the domestic front during H1 FY08, especially two consecutive floods in July-September 2007 and the devastating cyclone (Sidr) in mid-November 2007 including holdback in export demand, labor unrest in the RMG sector, and shaken business confidence acted as significant impediments to GDP growth, aggravated the supply disruptions, and fueled inflation during the period. To face the post-flood and post-Sidr crises, BB has raised the target for disbursement of agricultural credit by 32 percent to Tk. 83.7 billion and has taken steps to ensure smooth flow of credit to SMEs, small housing, women entrepreneurs, and to other productive sectors. Meanwhile, about Tk. 5.7 billion has been disbursed under the Small Enterprise Fund (SEF) up to end-November 2007. To boost up the activities in the housing sector, BB has introduced a housing refinancing scheme of Tk. 3.0 billion to meet the credit demand of middle and low income groups. Special credit facilities have also been arranged for fishing and timber businesses under the post-Sidr reconstruction and rehabilitation programmes. The disbursement of agricultural credit went up to Tk. 25.0 billion during JulyNovember 2007 compared with Tk. 17.5 billion during the same period of the last year. Moreover, the government has taken several measures to ease the inflationary pressure which include withdrawal of import duties, importation of food grain by the government, strengthening of internal procurement, provision for subsidy on fertilizer and diesel, and widening of the social safety nets programmes. BB sold foreign exchange worth USD 185.0 million during H1 of FY08 to ease the pressure on foreign exchange due to increased import of food and other essential items. Besides, the banks have been encouraged to provide credit facilities on softer terms to new importers, ease the LC margin for food items, extend the time limit for

customer facility, and arrange a greater flow of agricultural credit especially to the disaster affected areas. In view of the buoyant global demand in the face of tight world supply and present domestic supply constraints, the supply side factors are likely to play the major role in moderating the inflationary pressure in the economy and determining the course of inflation in H2 FY08. BB’s policy stance would support domestic output growth, especially agricultural production and production in the SME sector, along with keeping the demand side pressures under control so that inflation expectations remain subdued. During FY07, the average CPI inflation was 7.2 percent; with the average food and non-food inflation of 8.1 percent and 5.9 percent respectively. BB has revised PAU’s recent inflation projection and projects that the average CPI inflation is likely to lie in the range of 8.0 percent and 8.2 percent in FY08. It is also projected that during FY08 the average food inflation would remain between 9.1 percent and 9.3 percent while the range of non-food inflation is likely to be between 6.4 percent and 6.6 percent. 6.1.5 Recent External Sector Developments The trade deficit widened to USD 1,739 million during the first four months of FY08 as a result of robust import growth (by 19.5 percent on adjusted fob basis) and negative export growth (by 3.1 percent on adjusted fob basis). As a result, despite a healthy growth in workers’ remittances (by 28.7 percent over the same period), the current account balance showed a deficit (USD 229 million) in JulyOctober 2007 as against a strong surplus (USD 334 million) in the same period of 2006. However, with the causal factors underlying the decline in RMG exports taken care of, there are signs that export growth would soon bounce back to its trend level and Bangladesh would be able to maintain reasonable external sector stability during FY08 through materializing its good export prospects, ensuring the present healthy growth in the inflow of workers’ remittances, and maintaining a strong foreign exchange reserve position. Since the beginning of FY08, the foreign exchange market has remained orderly although Taka exhibited marginal appreciation against USD as of end December 2007 indicating healthy situation in the balance of payments, build up of foreign exchange reserves, and appropriate policy stance of the Bangladesh Bank, such as intervention by sale of USD in the interbank market. During the period, the nominal

effective exchange rate (NEER) appreciated while the real effective exchange rate (REER) depreciated. Despite some appreciation in the nominal exchange rate, the rate remained higher than the REER based exchange rate as a result of which Bangladesh enjoyed some competitiveness in the international market. Given the present comfortable foreign exchange reserve position, the appreciation of Taka would contribute towards easing the inflationary pressure at least in part by discouraging the pass through of international prices on domestic inflation. Nevertheless, recognizing the multidimensional nature of current inflationary forces, Bangladesh Bank will make the best possible real-time judgments regarding the extent to which the recent developments in the external sector are likely to affect economic activities during the rest of the period of FY08. 6.1.6 Fiscal Sector Developments In the FY08 budget, total current expenditure is set at Tk. 529.0 billion while total development expenditure is Tk. 285.2 billion. The overall budget deficit is projected at Tk. 223.1 billion (4.2 percent of GDP excluding grants and BPC), to be funded by Tk. 42.6 billion in foreign grants, Tk. 63.1 billion in net foreign borrowing, and Tk.192.8 billion in domestic borrowing including bank borrowing of Tk. 72.5 billion. The BPC’s accumulated loss of Tk. 75.2 billion is included in the budget although this would not create any immediate additional fiscal liabilities as it would be financed by issuing ‘Non-Cash Bonds’. Since the beginning of FY07, a modified arrangement for government bank borrowing was put in place under the supervision of a Cash and Debt Management Committee (CDMC). The new arrangement included a widened ways and means advance limit (Tk. 10.00 billion instead of the earlier amount of Tk. 0.64 billion) and auction of Treasury bills and bonds according to volumes pre-announced in the borrowing calendar. This new arrangement segregated the BB’s role in government debt management from its monetary policy operations although there does not exist any in-built mechanism to limit government bank borrowing within the ceiling of budgetary provisions. Following the changed treasury rules, the BB holds Treasury bills and bonds at cut off rate if market supply of fund falls short of government’s demand set by CDMC (known as devolvement). From Q4 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. Since the beginning of FY08, the devolvement system has been replaced by a system where the extra amount has been devolved to the primary dealers on the basis of underwriting. It is expected that the new system would encourage the primary dealers to create a secondary market for government securities and contribute towards improving the quality of monetary management by BB. In FY08, the targets for overall revenue earnings and expenditure have been fixed at 10.8 percent and 16.4 percent of GDP respectively. In the first four months of FY08, NBR tax revenue registered a 22.5 percent growth over the corresponding period of FY07. Among the NBR components, income tax recorded a growth of 44.7 percent compared with the growth of 20.8 percent during the same period of the last fiscal year. The flow of foreign fund also notably increased over the same period in the previous fiscal year. As such, the government (net) borrowing from the banking system has been much lower than the programme limit although the government is currently facing the challenge of funding the massive rehabilitation and reconstruction programme after the floods and the cyclone.

6.1.7 Recent Monetary Developments Bangladesh Bank has been following a monetary policy stance since H2 FY05 aimed at containing demand side pressures that contribute to inflationary build up in the economy. Despite significant pressure from rising prices in the international market and production shortfalls of major commodities in the domestic economy, an upward revision of the policy interest rates and reintroduction of BB bills in FY07 helped in limiting inflation at 7.2 percent, which is not far off the targeted rate of 7.0 percent for the year. However, the growth in M2 at the end of June 2007 exceeded the target (actual of 17.0 percent as against the target of 14.7 percent) and the growth rate of private sector credit was 15.1 percent compared with the programmed rate of 13.9 percent and the previous year’s growth rate of 18.3 percent. The net foreign assets of the banking system maintained its growing trend which helped to build up the

foreign exchange reserves that reached USD 5.5 billion by the end of H1 FY08. Keeping in view the price situation and enhanced excess liquidity emanating from the moderated demand for private sector credit and increase in net foreign assets, BB pursued growth supportive monetary policy stance in H1 FY08. During H1 FY08, BB introduced the required flexibility in implementation of its policies to meet the short term exigencies especially after the floods and the cyclone, such as ensuring the flow of adequate credit to productive sector like agriculture, SMEs, low cost housing, and other priority sectors and to women entrepreneurs. Moreover, BB’s response to disasters during the period has been reflected in the holding of installments of agricultural loans in disaster affected areas and the extension of loan amounting to nearly Tk. 127.5 billion by private banks as agricultural credit during FY08. The BB’s refinance scheme for housing loans for lower and middle income groups was also put in place. The period also recorded a reduction in the gap between short- and long-term rates of Government securities brought about by lowering the interest rates on long term Government securities in order to dampen inflation expectations. For reducing the pass through of international prices on domestic inflation, BB also undertook measures to arrest the depreciation of Taka so that the cost of imports does not rise too much. It may be mentioned that the BB has taken utmost care to minimize any potential adverse impact on exports and the inflow of remittances. With the observance of financial discipline and introduction of significant reforms in the monetary arena, M2 recorded a growth of 14.2 percent (y-o-y) at end October 2007. The growth of private sector credit stood at 16.3 percent at the end of October 2007. BB has taken steps to ensure close supervision on the performance of three state owned commercial banks (SCBs), Sonali, Janata and Agrani Banks, which have recently been transformed into public limited companies. This will help to improve their efficiency.

6.2 MONETARY POLICY STANCE, JANUARY-JUNE 2008 In view of the urgent need to build smooth adjustment capacity to the internal and external shocks that the economy has faced during H1 FY08, the monetary policy stance for H2 FY08 would aim at bringing about a qualitative change and a perceptible strategic shift in monetary policy formulation and its conduct to allow greater scope for supporting growth enhancing policies in line with the emerging developments and requirements of the economy. The efforts would be directed at gearing up economic activities by encouraging adequate credit flows to all productive sectors, especially to agriculture, SMEs, infrastructure, and other rural activities, for recouping the losses due to floods and cyclone and improving the domestic supply situation. The policies would also facilitate the import of essential commodities to ease the shortages in the domestic market. At present, the excess liquidity existing with the DMBs does not indicate any significant demand side pressure on the economy. However, with expected increase in economic activities in the coming months, the demand for credit may go up and if such a situation arises

the policy stance would be to contain the demand side pressures without hurting the investment demand in the economy. The monetary programme and consistent targets for reserve money (RM) and broad money (M2) expansion for FY08 would be set using the new targets for real GDP growth and inflation. The long term interest rates have already started to fall in the first half of FY08 despite high inflation. This shows lower inflationary expectations and is an indication of the prudent policy stance of BB. The overnight money market and other short term rates have experienced a remarkable stability and remained relatively unchanged. For liquidity management, BB would use appropriate policy instruments when needed. The approach to dealing with RM growth would focus on ensuring more effective management of government borrowing from the banking system. In order to help reduce the pressure on RM growth and contain inflation within its targeted level, it would be prudent for the government to ● progressively retire the borrowings from the BB; ● adopt and adhere to quarterly ceilings on borrowings from the BB; and ● gradually move towards a more balanced domestic debt strategy such that the budget deficit is financed through long term borrowing sources that are relatively less inflationary. BB, on its part, would increasingly encourage the banking sector to cater he credit needs of the productive sectors of the economy with special emphasis on agriculture and SMEs. In the past, BB has urged the banks to reduce their lending rates and improve the situation so that the high cost of borrowing does not put undue pressure on investors. BB would continue its efforts to lower lending rates, increase competition among the financial intermediaries, and also urge the banks to use the excess liquidity to expand their credit operations. BB would continue to pursue strong monitoring and supervision measures so that financial institutions reduce administrative cost by improving managerial efficiency and reducing the burden of non-performing loans. For successful implementation of the policy stance during H2 FY08, it would be critical to achieve greater fiscal and monetary coordination such that the imperatives of the monetary policy stance are clearly recognized within the policy framework and the relevant policy parameters are aligned with their projected values ensuring macroeconomic stability and rapid growth. The monetary management in H2 FY08 would no doubt be complicated and demanding, especially as a consequence of the adverse impact of the supply side

factors (particularly that of natural disasters and high and volatile international prices), and potentially rising demand pressure especially through the strong growth of workers’ remittances. BB would monitor the implementation of the policy stance on a regular basis and would take appropriate measures, as and when needed, to mitigate the risk of adverse implications to proper monetary management. BB’s role in developing the primary and secondary markets for government securities will be further strengthened, including measures to improve the roles of primary dealers and banks. The primary challenge of the monetary policy stance for H2 FY08 remains the achievement of the targeted rates of economic growth and CPI inflation. Although the BB is determined to take all necessary measures within its monetary framework to achieve the targets, BB is also conscious of certain factors that pose internal and external challenges and downside risks towards achieving the desired outcomes. Rapid and effective measures of rehabilitation in the flood and cyclone affected areas are crucial such that the adverse impact of the disasters are mitigated within the shortest possible time, production losses are recouped at least partly, and the supply of agricultural and other products increases to create positive effect on food and other essential commodity prices. There are several factors that would be critical to effective monetary management under the policy stance during H2 FY08: (i) Re-evaluation of the present subsidy policy as a consequence of rapidly escalating subsidies on energy products due to surging oil prices in the global market; (ii) Power, transport, and other infrastructure constraints affecting production and other economic activities; (iii) Business confidence to accelerate private sector investments and production activities; (iv) Impact of phasing out of restrictions in 2008 on textile exports of China; and (v) Reasonable socio-political stability, and continuity of policies in the backdrop of general elections scheduled in late 2008. BB, on its part, would remain vigilant regarding the above and any other unexpected developments and unfolding situations. The availability of new data and Information may necessitate the revision and adaptation of some of the monetary instruments presented in this MPS using the flexible framework of the monetary policy stance for the period H2 of FY08 with the aim to promote rapid growth with

price stability and support accelerated pace of employment creation and income generation for the people of Bangladesh.

6.3 Limitation of Monetary Policy in Developing Country In developing country, monetary policy suffers from the following limitations — 01. In under developing countries, and capital markets are narrow and unorganized. Hence, the credit control mechanisms like open market operation, bank rate, etc. cannot be effective. 02. Commercial banks keep cash reserve in excess of legal reserve requirements. In such a context, the purpose of the higher bank rate becomes defeated. The commercial banks do not go to the central bank when the latter expects them to geo. Similarly, in this situation, the instrument of reserve requirement does not function properly. 03. A narrow bill market makes the discount rate ineffective. 04. The existence o non-bank financial intermediaries also makes the credit control measures of the central bank ineffective, because, such intermediaries like sahukar, village money lender, etc. cannot be brought under the control and regulation of the banking system. 05. For all these reasons, monetary policy for controlling inflation in backward countries has not been very effective.

06. In order developed countries, banking habits are also underdeveloped which hampers the effectiveness of monetary policy seriously. 07. In backward countries, monetary expansion generally leads to increase imports, unfavorable balance of payments and loss of gold reserve, etc. 08. By its nature, monetary policy is not effective in the short run. 09. The role of monetary policy is not compulsive but permissive. This seriously limits the efficiency of monetary policy in backward countries. 10. In under developed society where liquidity trap is in existence monetary policy cannot work efficiently. 11. Administrative honesty and firmness are not very rigorous in less developed countries which reduce the efficiency of monetary policy a policy a lot. 12. Lastly, the lag between the decision about a particular policy and its implementation also hinders the monetary policy in its success. Here we found that monetary policy suffers from various limitations in the developing country. So, it should be supplemented by fiscal policy to make it effective. Despite this information, monetary policy sets the tone of economic development in recent years. Conclusion The Monetary Policy Statement (MPS) is intended to outline the objective and the modalities of formulation and conducting of monetary policies by the Bangladesh Bank, its assessment of the recent and the expected monetary and price developments, and the stance of monetary policies that will be pursued over the near term .Objectives of the monetary policies of the Bangladesh Bank as outlined in the Bangladesh Bank Order, 1972 comprise attaining and maintaining of price stability, high levels of production, employment and economic growth. In such a directed regime with little or no role of financial prices in influencing the magnitudes or directions of credit the present MPS (Monetary Policy Statement) provides the monetary policy stance that BB (Bangladesh Bank) intends to follow during the second half: January to June (H2) of FY08. The prime objective of the policy stance is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with ensuring reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal, and monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of FY08.

References 01. Banglapedia_allbd.com, use Subject: Ref-Banglapedia.SBD M_0309.htm 02. Bangladesh Bank, Monetary Policy Statement, January, 2006 03. www.cpd-bangladesh.org

04. Akram, Tanweer; "Bangladesh's Privatisation Policy", Journal of Emerging Markets, Volume 4, No. 2, Centre for Global Education, New York, USA, 1999. 05. Annual Report 2000, The Dhaka Chamber of Commerce and Industry 06. Bakht, Zaid; Preparation of the Sixth Fiver Plan: Position paper on Industry, January, 2001 07. Bangladesh Economic Review 1999, Ministry of Finance, Government of Bangladesh. 08. Bangladesh: Key Challenges for the Next Millennium, The World Bank, April, 1999 09. Centre for Policy Dialogue (CPD), "Changes and Challenges: A Review of Bangladesh's Development 2000"

10. Centre for Policy Dialogue (CPD), "Changes and Challenges: A Review of Bangladesh's Development 2000" 11. Centre for Policy Dialogue (CPD), "Changes and Challenges: A Review of Bangladesh's Development 2000" 12. Centre for Policy Dialogue (CPD), "Experiences with Economic Reform: A Review of Bangladesh's Development 1995" 13. Industrial Policy 1999, Ministry of Industries, Government of Bangladesh 14. Memorandum of the President of the International Development Assistance and the International Finance Corporation to the Executive Directors on a Country Assistance Strategy of the World Bank Group for the People's Republic of Bangladesh, March, 1998 15. Recommendations of the Seminars Organised by the Dhaka Chamber of Commerce and Industry in the Year 2000 16. Report of the Task Forces on Bangladesh Development Strategies for the 1990's, Developing the Infrastructure, Volume Three, University Press Limited, 1991 17. The Eighth Five Year Plan 1992-1997, Volume I, Planning Commission, Government of India 18. The Fifth Five Year Plan 1997-2002, Planning Commission, Ministry of Planning, Government of Bangladesh 19. Trade Policy Reform for Higher Growth, World Bank, 1996

Glossary Business cycle

CPI Current account deficit

Deflation

EFTPOS GDP–Gross Domestic Product

Growth

Output gap

PTA The cyclic movement of an economy between periods of high and low growth Consumers Price Index published by Statistics Bangladesh The amount by which national expenditure exceeds income over a particular period. If national expenditure is less than income over a particular period, then there is a current account surplus A decrease in average prices over time. In Bangladesh, this is usually measured using the all-groups CPI. Electronic funds transfer, point of sale. The total value of goods and services produced over a specified period, usually a year In an economic sense this is the increase in economic activity over a particular period (usually a year), measured as the percentage increase in GDP growth The gap between demand in the economy and the economy’s capacity to sustainably supply goods and services

Policy Targets Agreement OCR – Official Cash Rate Real interest rate Terms of trade

Inflation Price shock

MCI

MPS

The wholesale price of money, which is set by the Central Bank The rate of interest less inflation The ratio of the price of export commodities to the price of import commodities A sudden or unexpected shift in the price of a good or service This was a method for implementing the monetary policy.

The percentage of the working age population that is working or looking for work.MCI–(Monetary Conditions Index) Monetary Policy Statement