Recasting the interest rate, exchange rate and inflation narrative
Sajjad Zohir |
The Business Standard |
3rd February 2025 |
The magic perceived in high interest rates
Many argue that the remedy to all woes in Bangladesh’s financial economy lies in raising interest rates—be it in the name of repo, deposit rates, or lending rates. The arguments, if I understand the proponents, are as follows: An increase in interest rates will, firstly, increase the price of present consumption vis-à-vis savings (that is, future consumption).
The proponents possibly presume that this will increase deposits to banks, with less remaining in private hands to push prices of consumables up. Thus, an increase in interest rate works both to liquidate ailing banks by increasing deposits and to contain inflation.
Secondly, it will attract foreign private remittances, which will increase supply of foreign exchange, allowing an increase in the foreign exchange (FE) reserve as well as stability in exchange rates. The logic is often stretched further to argue that increased ‘macro-stability’ and adequate FE reserve will attract foreign direct investment (FDI), leading to increased employment and growth. With no good reason, some even hope to contain inflation in the medium to long term by following this route!
The first inference presumes that cash in private hands has only limited options: either spend on purchases of consumables or deposit in banks. This, however, is not true. People may hold on to cash in hand, which is especially true when sources of such funds are likely to be tainted.
People with cash savings in hand may also engage in self-financed (equity-based) investment, particularly on self-employed activities sought in distressed situations. While the last group may find high (deposit) interest rates attractive, diversion of funds away from micro and small investments adversely affects supplies, especially of food and other essentials, worsening the inflationary situation.
The second assertion regarding the inflow of private remittances is no less questionable. There was a time when foreign citizens of Bangladeshi origin (FCBOs) put their income from Bangladesh sources and savings sent from foreign lands to bank deposits (or Sanchay Patra) with high interest rates.
But several factors in the not-too-distant past prompted outward remittance by the same group. Those included a reduction in interest rate during FY2021-22, political uncertainties perceived to persist during 2025, and prevailing unknowns in post-tax net returns (especially for the FCBOs).
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Sajjad Zohir
Executive Director, Economic Research Group
sajjadzohir@gmail.com