Why price stability comes first in Bangladesh Bank’s monetary policy

The main objective of monetary policy in Bangladesh is price stability, which refers to low and stable inflation within the range of approximately three to four percent per annum. This rate of inflation appears generally acceptable to citizens and could be compatible with the empirically-observed growth-enhancing, if not the optimal, rate of inflation in emerging market economies such as Bangladesh. 

Bangladesh's economy was faced with major macroeconomic challenges when the interim government under Professor Mohammad Yunus came to power in August 2024. The macroeconomic challenges that the government encountered included high inflation of about 12 percent per annum, which depreciated the exchange rate of the domestic currency Taka and resulted in sharply declining foreign exchange reserves held mostly in US dollar. 

These factors prompted the government to introduce import restrictions over even basic necessities. In addition to these problems, the financial sector was in dire condition, with massive non-performing loans and recurrent liquidity crises for many banks. Many banks also encountered governance problems while holding large-scale non-performing loans on the asset side of their balance sheets. Since then, the Bangladesh Bank (henceforth, the Bank) has outlined many forward-looking strategies to generally achieve macroeconomic stability while specifically focusing on price stability. 

These strategies include the adoption of market-oriented monetary, credit and exchange rate policies and the introduction of banking and financial sector reforms aimed at achieving and sustaining both price stability and financial stability. 

The present high-inflation episode seems to have been generated primarily from the massive stimulus package made operational during the Covid pandemic of 2020-2023. Loose monetary and credit policies during the pandemic, which created excess liquidity in the banking system, led to distributed lagged effects on inflation and other macroeconomic variables. 

Food prices particularly remained sensitive to high inflationary expectations, originating from expansionary monetary and credit policies between 2020 and 2024. As it happened, during the early 1970s, the effects of inflationary expectations on food prices operated through both the demand and supply sides of food markets. 

One of the main objectives of the present contractionary monetary and credit policies is to lower inflationary expectations despite the absence of any pre-announced target rate of inflation. Present contractionary monetary and credit policies are expected to remain in force until the inflation rate declines to approximately between three and four percent per annum within a year or so. The Bank expects that the inflation rate will decline to say about five percent per annum by July 2026, if not earlier. 

The present policy interest rate of ten percent is expected to fall in line with the decline in the inflation rate. Ideally, the real policy interest rate should remain between two and three percent. As such a positive real interest rate would be ideal for savings, investment and growth, the Bank is expected to pursue a positive real interest-rate policy for a longer period.

The strategies and policy measures introduced by the Bank have been successful in bringing the inflation rate down, slowly and gradually, from 12% in August 2024 to the present level of about eight percent per annum. This inflation rate is considered high as it has the potential to aggravate macroeconomic imbalances through real interest and exchange rate channels. To avoid these problems, the Bank introduced a floating exchange rate system in May 2025 which has so far been successful in keeping the nominal exchange rate stable. The floating exchange rate system has been particularly useful in smoothing trade flows and in stabilising the economy by lowering inflation by four percentage points. Owing to large-scale foreign remittances of about three billion US dollars per month and healthy export earnings over the past year or so, current account deficits have been reduced significantly. All these factors have contributed to a steady increase in foreign exchange reserves to the present level of about 32 billion US dollars. It is expected that the level of foreign exchange reserves will increase to about 40 billion US dollars within a year or so. 

This level of foreign reserves would be adequate in financing import payments for about six months and would grow the confidence of citizens and the financial markets with respect to the Bank's ability to stabilise the exchange rate even in the unlikely scenario of any exchange-rate overshooting. Therefore, under present circumstances, the Bank does not have the intention to intervene in the foreign exchange markets unless the exchange rate becomes misaligned and/or it comes under speculative attacks through any unanticipated reasons. It is pleasing that the fear of a sharp depreciation of Taka, following the introduction of the floating exchange rate system, has faded away. 

There is also no evidence of panic in the foreign exchange markets, which is partly due to contractionary and disciplined credit policy measures of banks. Credit controls and regulations are indeed effective in preventing any speculative capital outflows when investors have incentives and hence may take one-way bet of depreciating the domestic currency. This happens when the currency is perceived as overvalued by investors such that any current account deficits may become unsustainable.  This could be part of realising the investors' self-fulfilling prophecies even when the economic fundamentals could be right.

The Bank holds the view that some restrictions on capital flows, and the continuation of disciplined credit policy, are essential to avoid speculative attacks on the domestic currency amidst economic and political uncertainties. The Bank remains agile and committed to keeping the exchange rate, both nominal and real, stable to facilitate trade flows and to avoid creating real exchange rate misalignment. However, despite some perceived restrictions on speculative capital outflows, the Bank allows capital inflows which remain linked to investment and business activities. 

As it is required, foreign borrowings are allowed for investment under flexible terms and conditions. The general restrictions on foreign borrowings are designed to lower the possibility of over-borrowing in the presence of perceived 'guarantee' of the Bank and/or the government of foreign borrowings of the private sector. The experiences of East Asian countries suggest that foreign borrowings carry exchange rate risks and could cause problems for banks and business enterprises in the event of a sharply depreciating exchange rate for domestic currency. Therefore, the Bank ensures that these risk factors are taken into consideration by the borrowers while making decisions on foreign currency denominated loans and supply credits. The Bank does not provide any explicit or implicit guarantee of foreign borrowings of the private sector. In general, such borrowings are negotiated under stringent terms and conditions as expected in commercial transactions which include borrowings of foreign funds.

The Bank's recent half-yearly Monetary Policy Statement (MPS) outlines the monetary policy stance in force during the first half of the fiscal year 2025-26. This Statement was prepared after consultations with major stakeholders and analyses macroeconomic conditions with a focus on inflationary conditions. 

The main objective of the MPS was to explain the Bank's stance on monetary policy over the next six months while keeping it consistent with the medium term framework of monetary policy in the process of being formulated. To make monetary policy effective in lowering inflation from its present level of eight percent to the level between three and four percent over the next year or so, the Bank would keep the stance of monetary policy contractionary. In addition, the Bank would continue financial sector reforms to the extent needed to bring financial stability with a focus on improving the health of the banking sector. 

The Bank expects that once the financial sector is stabilised, bank credits will flow smoothly to small and medium enterprises. Moreover, financially healthy and sound banks would be able to conduct their banking operations, in the form of deposit generation and lending, without bearing the burden of large-scale non-performing loans. There is evidence to suggest that present large-scale non-performing loans have originated from many unlawful lending practices and through the willful default culture of interlocking interest groups in society. The Bank does not condone such practices and has tightened regulatory policies to bring discipline in the lending practices of banks, especially in case of large-scale loans that bring windfall gains to interlocking interest groups. Here it can be noted that more than normal profits can be earned if an oligopolistic market structure exists in the banking sector. Bank regulators generally allow the existence of imperfect market structure even in advanced economies so that banks do not engage in speculative, risky investments and in the process, do not bring danger to depositors and make the financial sector unstable. The present monetary policy stance of the Bank accords well with ongoing banking sector reforms which will improve the financial health and soundness of the sector. 

The interest rate, exchange rate and credit policies, as suggested above, reveal that the Bank remains determined to decrease the inflation rate, by keeping the monetary-and credit policies contractionary, to a level say between three and four percent per annum within the next year or so. This is needed to: (1) keep the exchange rate, nominal and real, stable; (2) reduce the suffering of low socio-economic citizens from high inflation, and (3) restore citizen's confidence in the ability of the Bank to sustain low inflation. Low and stable inflation is expected to promote long-term investment, especially foreign investment, and economic growth. 

The present interim government is supportive of the contractionary monetary policy stance of the Bank. The government has tightened fiscal policy and brought fiscal discipline to the extent needed to make monetary and credit policies effective in lowering inflation and bringing stability in the financial sector. Although the rate of economic growth was relatively low in 2025 due to ongoing restrictive policy measures of IMF stabilisation programs, it is likely to accelerate in a low-inflationary environment. In a stable environment, investment is likely to increase in response to the present government's growth-enhancing policies which include financial reforms and encouragement of foreign investment. The greater availability of foreign reserves for the importation of machinery and raw materials would also help to promote investment, including foreign investment. 

At the moment, the Bank does not see the emergence of any credit-led boom-bust cycle in the presence of contractionary monetary and credit policies. Once financial sector reforms are complete and the inflation rate comes down to a low level, the Bank will consider the introduction of a rules-based monetary policy so that inflationary expectations remain anchored to the target rate of inflation. At this stage, the strategy of monetary policy to be adopted, whether that be monetary targeting, inflation targeting or any variant of each of them, has not been decided. Ultimately, it does not matter which strategy of monetary policy is adopted as long as exchange rates are determined by the market forces of demand and supply. At the same time, the Bank would keep the option open to intervene in the foreign exchange market when needed to stabilise the exchange rates. In addition, the Bank would continue holding the option of capital control policies as needed to neutralise any actual or potential speculative attacks on the domestic currency. 

Finally, the Bank looks forward to introducing a rules-based monetary policy at the earliest possible occasion once the inflation rate comes down to the low level of between three and four percent per annum which would be acceptable to the citizens. As it has been adopted in many countries, inflation targeting, in a flexible sense, could be an option for the Bank to consider as the strategy of monetary policy for Bangladesh. The introduction of inflation targeting would require sustaining stability of the exchange rate and restraining inflationary expectations in the midst of economic and political uncertainties. Accordingly, the Bank is working on the development of a general framework of monetary policy that would be analytically sound, easy to follow and remain credible to the public. Although a rules-based monetary policy is likely to be followed in principle, some discretion would remain for the Bank to formulate monetary policy as per the (amended) Bangladesh Bank Order. As it is required, Bank would maintain working relations with the government to coordinate monetary and fiscal policies. These policies remain interdependent. Although, as the banker of the government, the Bank would require financing of some budget deficits, the present contractionary monetary policy, as represented in the positive real policy rate, seems to be a message for both the government and the private sector in that the Bank is determined to follow through the process of decreasing the inflation rate. The alternative is sustaining high inflation which would create unsustainable macroeconomic imbalances in the midst of actual or potential political uncertainties. 

Once the inflation rate comes down to an acceptable level between three and four percent per annum, the policy interest rate would be lowered in a way that keeps the real policy interest rate within the range between two and three percent per annum. This positive real rate of interest would match the neutral or natural real rate of interest that is expected to prevail at the full-employment level of output or at the natural rate of unemployment.