Efforts to tame inflation in the country have hit a roadblock, with economists slamming the central bank’s SMART rate policy as ineffective. They point to delays in implementation and a lack of oversight as major reasons for its failure.

In spite of the implementation of the SMART rate, the Six-Month Moving Average Rate of Treasury Bill, the inflation rate rose last month, increasing discomfort with the cost of goods and services.

Different countries have chosen the formula of raising the interest rate to control inflation, which has yielded good results for them. Bangladesh decided to do the same through a contractionary monetary policy in July last year, but it came into effect in October that year.

Delays in implementation of the policy and lack of oversight led to inconsistent results, said economists. The loan interest rate is currently over 13.5%, and the inflation rate is about 10%.

Dr Ahsan H Mansur, executive director of the Policy Research Institute (PRI), told the Daily Sun, “There are precedents for controlling inflation by raising interest rates, but it is not being implemented properly in our country.

“There are faults in what is being done here in the name of SMART rate. Delays in implementation have not yielded benefits. The Bangladesh Bank is not on the right track in this regard.”

Echoing him former Bangladesh Bank governor Dr Mohammed Farashuddin said, “Many countries around the world have managed to bring down inflation, but in our country it still hovers around 10%. Inflation cannot be controlled by raising interest rates alone without increasing the money supply in the market. Supply of goods should also be increased to reduce inflation.”

Similarly, ex-governor of Bangladesh Bank Dr Salehuddin Ahmed said it is possible to control the rise in inflation in other countries by raising interest rates, but this model never works in Bangladesh.

In the past too, the rise in inflation could not be controlled by raising interest rates and is still not possible, because this sort of market management does not follow the rules of economics. Inflation cannot be controlled by reducing the flow of money and increasing the interest rate on loans, he said.

He also said in order to control inflation, market management must be disciplined. Syndicate violence must be stopped. Then the rate of inflation will naturally decrease.

He said, “Currently, production costs are increasing due to reducing the flow of money by increasing the interest rate to control the inflation rate. Import costs are increasing. Product prices are increasing. These are increasing the pressure on the market. As a result, inflation is also under pressure.

“A further disadvantage is that employment is not increasing due to the slowdown in trade and commerce. It does not facilitate the way to increase people’s income.”

Policy rate hike fails to tame inflation

When inflation is high, central banks around the world raise the policy rate, also known as the repo rate, to control it. Commercial banks borrow money from the central bank at the policy rate. When the central bank increases it, the interest rates of loans and deposits of commercial banks also go up.

If the policy rate is high, commercial banks are discouraged from borrowing money from the central bank.

Consequently, the policy rate affects the liquidity. That is, the market becomes tight. As interest rates become high, banks borrow less from the central bank. If banks borrow less, people get fewer loans.

As a result, there is less supply of money in the market. If the supply of money in the market is low, the price of goods cannot soar much. That is, if the demand in the market decreases, the price inflation decreases.

The Bangladesh Bank raised the policy rate by 25 basis points to 8% from 7.75% as the central bank unveiled a new monetary policy for the second half (January-June) of FY24 on 17 January. However, measures to control inflation by tightening the market did not work in the country.

In April 2020, the Bangladesh Bank fixed the maximum interest rate on bank loans at 9%. However, when the country’s economy faced a crisis due to the pandemic and the onset of wars in different countries, the central bank introduced the new SMART rate – six-month average interest rate of 182-day treasury bills – to determine the interest rate of bank loans from July last year.

According to the Bangladesh Bank data, during the first two months of the current fiscal year – July and August of 2023 – the loan interest rate was 7.10% and 7.14%, respectively.

Then, in September and October of that year, the rate was increased to 7.20% and 7.43%, respectively. In November and December 2023, it was further raised to 7.72% and 8.14%, respectively.

The benchmark interest rate at the end of January 2024 was 8.68%. In February of this year it was 9.61% and in March it jumped to 10.55%.

Banks are allowed to add 3% to the SMART rate to determine their lending interest. Previously, banks were permitted to add 3.50% to the benchmark rate.

On the one hand, the loan interest rate is increasing, and on the other hand, inflation is rising. The rate of this index of the economy has increased in last March compared to the previous month.

According to Bangladesh Bureau of Statistics (BBS) data, inflation was 9.81% in March this year. It was 9.67% in February and 9.86% in January this year, and 9.41% in December 2023 and 9.49% in November 2023.

Similarly, inflation in March 2023 was 9.33%, whereas in FY22 and FY23 it was 6.15% and 8.84%, respectively.