Macro Analysis /

Bangladesh MPS FY23: ‘Cautious policy with a tightening bias’; rate cap sustains

  • 50 bps policy rate hike to soothe demand side pressure

  • BB expects reserve money growth to rebound; also, credit growth to pick up driven by public credit

  • Current account (CA) deficit in FY23 could be similar to that of FY22; pressure on currency may continue

Shopnil Paul
Shopnil Paul

Research Associate

IDLC Securities
3 July 2022
Published byIDLC Securities

Bangladesh Bank (BB), the country's central bank, published its Monetary Policy Statement (MPS) for FY22-23 on 30th June 2022. According to the statement, the priority is to control inflation, manage exchange rate pressure, and ensure liquidity to aid the economic recovery while keeping a low interest rate regime. Overall, BB shifts from expansionary policy to a careful stance to ensure economic growth amid macro challenges.

50 bps policy rate hike to soo the demand side pressure

In recent MPS, BB announced repo rate hike by 50 bps from 5.0% to 5.5%, keeping the reverse repo rate unchanged at 4.0%. Please note that earlier on 29th May 2022, BB increased the policy rate by 25 bps to 5.0%. The 75 bps increase in policy rate within almost a month aims to tame demand size pressure to control inflation. However, such a policy measure is likely to counter two challenges. First, the cost-push inflation, resulting from supply-side constraint, is likely to persist until the commodity prices revert. Second, the continuation of the lending rate cap at 9% partially limits the repricing of debt at higher rates, which subverts the essence of policy rate hike.

However, BB intends to remain watchful

The increase in policy rate and minimum deposit rate (average of 3-month CPI inflation) set by the regulator are supposed to be challenging for the banking sector as such measures could increase the cost of funds and reduce spread. As a fact, the spread (difference between lending and deposit rate) dropped by 18bps from 3.20% in June 2021 to 3.06% in May 2022. BB expects that the pressure on spread to be maneuvered by improving operating efficiency through digitalization; at the same time intends to take policy measures should it be necessary. If the lending cap is relaxed, the banking sector is expected to see an increase in spread and profitability thereby.

BB expects reserve money growth to rebound; also, credit growth to pick up driven by public credit

Net foreign asset declined by 12.5% as BB supplied currency from reserve to support rising import costs amid economic recovery and global commodity price hikes. As a result, both reserve money growth and broad money growth underperformed, standing at 0.0% and 9.1% respectively in FY22E compared to the target of 10.0% and 15.0% respectively. Going forward, BB expects 9% reserve money growth and 10% broad money growth in FY23, a recovery towards a normal level.

The private sector credit growth is expected to be 13.1% in FY22, up from 8.3% in FY21 because of economic recovery; however, underperformed the target of 14.8%. Public sector credit growth, on the other hand, is expected to be 27.9% in FY22, close to the target of 32.6%. Going forward, private sector credit growth is expected to be 14.1% in FY23, a downwards revision from the previous year’s target. But overall domestic credit growth is likely to reach 18% mark in FY23, driven by 36.3% growth in public sector credit as more financing would be required to subsidize high fuel and fertilizer prices.

Inflationary pressure likely to persist in FY23, could be from 6.4% to 7.5%*, as BB projection suggests

The current 12-month average inflation stood at 5.99% as of May 2022, above the target ceiling of 5.30%; whereas the point-to-point inflation stands at 7.42% as of May 2022. BB considers plentiful catalysts such as - commodity pressure from geopolitical tussle, lockdown in China, BDT depreciation, the hike of domestic energy price, flood during monsoon, and rising inflation in trade partner India – to be possible drivers of inflationary pressure. As a response, BB plans to offer refinance schemes for import substitute products and increase LC margin to discourage the import of luxury goods.

Current account (CA) deficit in FY23 could be similar to that of FY22; pressure on currency may continue

On the back of global economic recovery, export demonstrated 34% growth in 11M FY22. The import grew by 41% because of pent-up demand, rising input costs for RMG exports, cost hikes for food grains, fertilizers, petroleum products and industrial raw materials. As a result, BB expects that the trade deficit is likely to be USD 33.2bn in FY22. The remittance is likely to be USD 21.3bn in FY22 compared to USD 24.8bn in FY21 due to base effect and higher inflow through the informal channel as international travel resumed. Overall, BB expects CA deficit to be USD 17.7bn in FY22, 3.8% of FY22 GDP.

The CA deficit put exchange rate under pressure, resulting in 9.2% BDT depreciation in FY22, despite BB sold USD 7.3bn greenback to commercial banks. Therefore, forex reserve is likely to come down to USD 42.0bn in FY22 from USD 46.4bn (-9.5%) in FY21. Please note that we had CA surplus in FY15 and FY16 and CA deficit from FY17 and onwards. Prior to FY22, CA deficit stayed 0.5% - 1.5% to GDP, except in FY18, when it reached 3.0%. In FY18, BDT depreciated by 3.7% and forex reserve declined by 2.3%.

Going forward, BB expects USD 36.7bn trade deficit due to (a) slowdown in export in USA and UK amid recessionary pressure; (b) high level of commodity prices, slightly offset by policy interventions mentioned above. Remittance, on the other hand, is expected to increase to USD 24.5bn (11.4%) as nearly 1mn expatriates, the highest in the past 8 years, joined overseas employment in FY22 since the economic conditions of the middle eastern countries, a major destination for expatriates, have improved driven by higher oil prices. So, overall BB expects USD 16.5bn CA deficit, which is slightly down from FY22 estimates. BB expects to match the deficit by a 23% growth financial account, thus keeping forex reserve around USD42bn. While the projection seems to have found a way to neutralize currency pressure, any adverse change in underlying assumptions, due to geopolitical and economic reasons, would put a further burden on the exchange rate.