Bangladesh Bank (BB) opted to increase the policy rate, signaling the beginning of a tightened monetary cycle to contain inflation and easing pressure on the exchange rate.

The highlights of the announcement are as follows:

• Bangladesh Bank has increased the policy rate by 50 bps to 5.5%, while reverse repo remains unchanged at 4.0%.
• The private sector credit growth target has been set at 14.1% for FY23, which is 70 Bps lower than the last year’s ceiling.
• The broad money growth target has been set at 12.1%, down from 15% last year.
• The lending rate cap will remain fixed at 9.0%.
• BB to introduce a new refinance line of credit for import-substituting products, while LC margins for luxury goods and other non-essential items will be increased to discourage their imports aiming to contain pressure on the exchange rate.

CAL’s VIEW: While the stated objective of BB to tighten monetary conditions further is in line with our expectations, we believe it will have to move further and faster in order to contain macro pressures

Interest rate expectation:

BB has now raised monetary policy rates by 75bps this year. BB’s efforts thus far to ensure an orderly depreciation of the currency have also resulted in a tightening of liquidity conditions, pushing up treasury yields as well.

• We expect the rate hikes announced thus far to bear the signaling effect of BB’s tightening objectives this year. However, we expect further rate hikes throughout the year to keep pace with global central banks which are moving in tandem to tackle inflationary pressures. Provided the US Fed follows current projections, we expect BB to hike policy rates by a further 150-200 bps in the remainder of 2022.
• With the increase in underlying interest rates, the existing lending rate cap is no longer tenable. Banks will naturally be incentivized to invest in government securities viz a viz lending in the wider market. The rate cap also prevents the effective transmission of monetary policy into the wider economy. CAL believes that policymakers are likely to revisit the lending rate cap shortly in order to address this mismatch.
• Pursuing a policy target where broad money growth is lower at 12.1% compared to private sector credit growth at 14.1% is likely to induce a liquidity shortage.

Exchange rate expectation:

• The movement of the exchange rate is likely to be largely determined by the scale and pace of monetary tightening. Holding our view of a balanced approach from the BB, we expect that the BDT is likely to continue its depreciating trend (expected 6-7%) and end the year at BDT 104.
• We condition this expectation on a gradual increase in interest rates from BB. A slower than expected tightening could place further pressure on the BDT, while a faster and more effective move could contain BDT below 100 against USD.
• Further increasing LC margins for luxury goods and other non-essential items may reduce pressure on the exchange rate. However, it is likely to fuel further inflationary pressure. Introducing a new refinance line of credit for import-substituting products may end up stoking additional demand for foreign exchange owing to the dependence on imports to support import-substituting products.