The H1 Monetary Policy Statement (MPS), announced by Bangladesh Bank governor Abdur Rouf Talukder this week and applicable to the first half of the 2023-24 fiscal, was a pretty routine response to the needs of the hour, which are to move towards a market-based interest rate, towards a unified exchange rate and to curb inflation.

The rise in the policy rate by 50 basis points (0.5%) would make credit costlier for the banks from the central bank, and this would be passed through to borrowers. In the process, this will help the central bank mop-up excess liquidity from the market.

The MPS seeks to reduce both broad money in circulation and private sector credit growth, and hence can be said to be contractionary, as is normal for the effort to rein in inflation. The move is in sync with the central banks of many of our neighbouring countries, like the Reserve Bank of India and the Bank of Thailand, who have used it to restrict inflation successfully for quite some time, achieving inflation rates of 4.3 percent and 2.7 percent respectively. It is based on the quantity theory of money, according to which prices vary in proportion to the money supply.

The new MPS of Bangladesh tries to make credit costlier by raising both policy rates and providing flexibility to the banks in setting interest rates based on a reference rate plus a margin of 3 percentage points that they can add on. The broad money and private credit growth rates have been reduced to reduce the money supply in the market. Most economists have said If implemented well, this monetary policy will give a proper signal that the central bank is willing to use the tools at its disposal to address inflation which has been rising persistently.

The monthly inflation rate in May soared to a decade-high of 9.94%, up from 9.24% in April, according to the Bangladesh Bureau of Statistics (BBS). What the economists support even more is the move to come away from the previous policy of setting a cap on the interest rate, the so-called '9-6' policy.

Once inflation crossed this ceiling rate, you had large entrepreneurs getting loans at negative real rates of interest. This encouraged the willful borrowers to take more loans, not necessarily for productive investment. The risk of a rise in non-performing loans increased in the process. The central bank will still have control over the reference rate, which it said will be based on the average interest rate of the six-monthly treasury bond. By and large though, this has to be seen as a step forward in the right direction.