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Protecting our financial framework

Mamun Rashid
THROUGH monetary policy the central bank of a country controls supply, availability and cost of money so as to achieve optimum growth and economic stability. Monetary policy is flexible i.e. immediate changes can be made in response to shocks, as opposed to fiscal policy, which takes longer to manage and implement.
Monetary policy can be expansionary, i.e. increasing the total supply of money, as opposed to being contractionary, which decreases cumulative money supply. Expansionary policy is adopted when confronted with unemployment during recession by lowering interest rates. Conversely, contractionary policy is espoused to stabilise inflationary pressure through elevated interest rates. Lately, we have been hearing about “accommodative monetary policy" -- warranting a balance between growth and inflation. In such policy’, we sec relatively quick shifts from expansionary to contractionary measures and vice-versa to fine tune growth in an economy prone to inflationary pressures.
Advanced economies formulate monetary' policies based on a wide range of factors, including short and long term interest rates, velocity of money, exchange rates, bonds and equities government versus private sector spend-ing/savings, international capital flows and financial derivatives. Developed
nations often use advanced tools like quantitative easing, an asset-repurchase program employed by the Bank of England to combat recession.
Conversely, in emerging economies' policies, are often constrained by underdeveloped financial markets, low per capita income and significant poverty. The scenario is complicated additionally by existing political and economic pressure. The central banks of the emerging world have to design prudent regulations and maintain exchange rates within a specific range while managing domestic activity and inflation.
Since inception monetary policy in Bangladesh was conducted with full direct control on interest rates and exchange rates, as also on the volumes and directions of credit flows. However, as of today, directed lending has been abolished and gradual liberalisation of interest rate has taken place. Thus, interest rates have become market driven. Exchange rate has become floating, with Bangladesh Bank (BB) buying or selling currencies to keep liquidity at desired level, though we at times hear about "managed float" or "moral-suasion."
BB has reverted over to open-market operations mainly through government treasury bills (T bills) auctions. As a result Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) have become more stabilised.
Bangladesh's Monetary Policy Statement (MPS) for July-December 2009,
released by Bangladesh Bank, is geared towards addressing stable rate ot inflation, high capacity utilisation resulting in low level of unemployment, optimum economic growth and effective exchange rate management.
The discussion of the core strategies adopted by Bangladesh Bank in the MPS July-December 2009 is categorised into the following facets:
• Inflation: In Bangladesh inflation exhibits an upward trajectory compared to the International Monetary Fund's (IMF) forecast of one percent decline in consumer prices in emerging and developing economies.
High growth of reserve fund has induced excess liquidity in the system, resulting in inflationary pressure. Elevated reserve fund was due to enhanced Net Foreign Asset (NFA) build-up caused by continued large remittance inflows and decline in import payments. However, BB has estimated a declining NFA, resulting in a decline of foreign reserves, thus diminishing inflationary pressure. The decline in domestic annual average CPI inflation is estimated to be slower in FY 2010, and is projected to be at 6.5 percent by June 2010.
• Capacity utilisation: Domestic investment gets discouraged due to prevailing high cost of funds. BB, has, therefore, prescribed lending rate ceilings in priority economic sectors to accelerate growth and employment. As treasury yields and deposit rates have declined BB has taken mandatory as opposed to advisory steps to diminish interest rates and service charges. BB programs have placed greater directional emphasis on credit needs of agriculture and Small and Medium Enterprises (SME), which are grossly underserved by the market.
However, analysts opined that move-
ment from market-based financial intermediation should be temporary as priority sectors may become credit starved due to banks diverting to nonpriority sectors due to higher rates.
• Exchange rate management: BB has kept BDT at an undervalued stable level with continuous foreign exchange purchases from the domestic market to protect export competitiveness and to maintain incentive for remittances. In the existing recessionary environment this can be viewed as a prudent move as export sustainability has become an impera-tive issue. 5
• Sovereign credit rating of Bangladesh: | BB has finalised steps to for obtaining $ the credit rating, thus facilitating lower a costs for private sector borrower and 5 banks. However, the government 8 doesn't have immediate plans of bor- , rowing on commercial terms from the international market.
• Economic growth: BB maintains enabling credit conditions to sustain growth in a global recessionary environment. Real GDP growth for FY 2010 is estimated to be 6 percent given all parameters set by the policy is met at a desired level.
Some economists in their analytical commentary have expressed the view that the MPS should have addressed the scenario as a significant portion of the classified loans can be attributed to public sector corporations. However, bad debts cannot be associated directly with the MPS and is more linked with credit recovery regulations and frameworks and, as such, the MPS shouldn't be criticised in this accord. It is also not prudent to discuss the bad debt and classified loan scenario in details in the monetary policy.
Implementation of Basel II Framework protects the financial system against risk of overexposure. BB has commenced
Basel II capital adequacy assessment for banks from January 2009 to instill quantitative awareness in banks about all material risks associated with their operations and capital bases.
Analysts have criticised the MPS due to absence of detailed Indications and guiding principles of mandatory compliance for the banks. Since financial Institutions are encouraged to lend at lower rates to priority and often riskier sectors it is expected that Basel II Framework would be risk adjusted likewise, thus regulating banks to keep reserve according to their future risks.
Nevertheless, the MPS is not a regulatory framework exhibiting precise details about each and every single policy stance, rather the policy statement outlines BB's standpoint towards attaining highest sustainable economic growth without triggering a surge in inflation rates. There are other committees within the government and central
bank where capital adequacy framework can be discussed in detail.
Monetary policy statements in developed countries are generally short and precise, primarily focusing on the state of the economy and the stance (e.g. expansionary, contractionary) the monetary authority might be taking to sustain growth and to keep inflation at a reasonable level. It is more of a framework or direction — rather than detailed discussion of the policy measures. Our monetary policy statements have also given us the government's view of the economy from time to time. We can, of course, support or debate the views of the government on the economy and inflation. However, it would be unjust if we expect something out of the monetary policy statement for which monetary policy is not meant to be.
Mamun Rashid is a banker and economic analyst