SAARC Common Currency and Corruption Legalization

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After the Second World War, the world experienced a major change in terms of economic cooperation. The growth of regional economic cooperation arrangement is one of the major developments in the post war period. The formation of regional integration has been greatly successful in brining historically hostile countries together. Both economic and political factors are responsible for the formation of regional agreements, but economic factor is the prevailing factor in pushing a country towards regional integration. The classic example is the states in the European Union and the Southeast Asia where economic dimensions have brought long time foes in the same dais.
The basic premise on which SAARC was founded was that by activating cooperative cultural identities and economic interests, political conflicts and tensions in South Asia could be moderated, if not completely eliminated. SAARC now stands at a critical stage of are evolution where, given the right push, it can overcome past constraints and barriers to emerge as a dynamic factor in the peace and prosperity of more than a billion South Asians. The recent SAARC head of states conference in Dhaka showed a hint of improved cooperation among the member countries. The activation of SAFTA is a step towards more integrated economic cooperation.
A common currency’s attraction is that it doesn’t represent the currency of any single country. From an economist’s point of view, it’s advantageous to deal with a lesser number of currencies since each time one converts a currency there is a huge loss. From the perspective of comparative advantage enjoyed by some of the South Asian countries in export of certain items like tea in the case of India and Sri Lanka, jute in the ca e of Bangladesh and India, basmati rice and cotton in the case of India and Pakistan, it looks advantageous if SAARCcountries could adopt a single currency-substantially enhancing their bargaining power together in the world market.
This report evaluates the opportunity of introducing a common currency for the SAARC and also examines the feasibility of that common currency while taking overall current situation under consideration.

Common Currency:
Common currency means that individual countries do not have their own currency, and whole task of currency creation and monetary policy is agreed at a regional level with agreements on national component of currency and money creation. Interest rate hand exchange rate policies are also centralized. That system requires surrender of monetary sovereignty associated with currency creation and monetary expansion.
In the context of European integration movement, the first stage was introduction of European Currency Unit (ECU), a composite monetary unit consisting of a basket of European Community currencies and the process of consolidation under European Monetary Union (EMU) before gradual evolution to the single currency, Euro.

Rupa the suggested name of common currency
Rupa, the suggested name for the proposed common currency of SAARC countries, gets a thumbs-down from image-builders
What’s in a name? Everything, it seems. With news of the proposed common currency for SAARC countries being announced, the suggested name ‘Rupa’ has already raised its share of chuckles. Rupa? It sounds like someone is soliciting! Guffaws ad film-maker Prahlad Kakkar, ‘‘Imagine, you walk into a shop and ask for the price and they say, paanch rupa!’’
Tut-tuts Cyrus Oshidar, vice-president and GM (creative and content), MTV Networks India, It sounds like a bad joke. They need to hire an ad agency to come up with something better.’’ The jokes continue with theatre director and adman Rahul Da Cunha: It’s an awful name for a common currency. It would be so embarrassing for a woman with the same name!’’
The proposal for the common currency, to be commissioned with the help of WTO by 2010, has yet to be ratified. However, former Pakistani foreign secretary Niaz Naik has reportedly stated that his country would support the proposal in the wake of improved relations between India and Pakistan.

But in the land of numerological-enhanced, tongue-twisting Kkusum and Kasautii Zindagi Kii, a name is not just a name. And with semantics coming into play, connotations raise their head. ‘‘Rupa sounds like a banian,’’ says Cyrus, ‘‘A lot of thought should be go into the selection of the name. It’s about semantics, really. We have to focus on what we are projecting. For instance, the Euro connotes a unified Europe. When we choose a common name for the SAARC currency, it’s important that it should project a positive image —one with local sound and colour which evokes a forward-looking picture of the region.’’ Says Prasoon Joshi, national creative director, McCann Erickson, ‘‘A name should be more than just an abbreviation.’’ But the finance guys don’t necessarily agree. Says ABN Amro Bank CEO Ramesh Sobti, ‘‘As the rupee is the dominant currency, the name is good enough.’’
Any off-hand suggestions for names? Prasoon picks his three choices: ‘‘Yaari —to signify the friendship between SAARC countries; Mudra, meaning currency; and Daulat, meaning wealth.’’ Prahlad’s suggestion: ‘‘Rupiyah, because it is used in other South East Asian countries.’’ Rahul would opt for ‘‘SAARC — for all the SAARC countries. ‘Any takers?

Discussion In Light of European Union & Euro
As discussed in the introduction, political and economical factors are the stimulus for pushing countries towards regional integration. European Union is the precise example in this case. After the Second World War, the whole Europe was left, by economic and human destruction. The then European political leaders realized that the only way to recover from this devastating situation was to go for a greater cooperation among the European Countries. Many organizations were formed, including the European Economic Community (EEC), which eventually emerged as the organization that would bring together the countries of Europe into the most power full trading bloc in the world. The EEC, later called the European Community (EC), and finally the European Union'(EU), set about to abolish internal tariffs in order to more closely integrate European Markets and allow economic cooperation to help avoid further political conflict. EU ultimately succeeded in pursuing its goal and currently EU is the only monetary union in the world.
The three stages to achieve EURO as follows:
1. Reduction of the fluctuation margins between Member States’ currencies, broad guidelines for economic policy at Community level, co-ordination of budgetary policy, preparation of Treaty changes to facilitate later stages of EMU.
2. Integration of financial markets and banking systems to create free movement of capital, progressive elimination of exchange rate fluctuations, closer co-ordination of short-term economic policies and budgetary and fiscal measures.
3. Irrevocable fixing of exchange rates between participating national currencies, convergence of economic policies, establishment of a Community ‘system of central banks.

European Monetary System
Following a Franco-German initiative, the Community decided to re-launch monetary integration at the Brussels European Council by creating a European Monetary System (EMS), with the objectives of stabilizing exchange rates, reducing inflation, and preparing for monetary integration. The EMS entered into force on 13 March 1979. The system consisted of three elements:
1. Currency basket (European Currency Unit or ECU);
2. Monetary stabilization mechanism (Exchange Rate Mechanism or ERM);
3. Mechanism for financing monetary interventions (European Monetary Co-operation Fund or FECOM).
The ERM gave each currency a central exchange rate against the ECU, which also gave them central cross rates against each of the other participating currencies. Participants were then required to maintain their exchange rates within a 2.25% fluctuation band above or below each bilateral central rate, except Italy, which had a margin of6%, and the United Kingdom, which initially remained outside the system.

The Euro system’s primary objective is the maintenance of price stability. It meets its objectives through:
(a) Deciding and implementing monetary policy;
(b) Conducting foreign exchange operations;
(c) Operating payment systems’. The NCBs’ of the participating Member States played a key role in the smooth transition to the euro. Their responsibilities have included:
(a) Introducing the euro in their respective countries;
(b) Managing the changeover from national currencies to the euro;
(c) Creating the necessary systems to effectively circulate the euro banknotes and coins;
(d) Withdrawing national currencies; and
(e) Providing advice about and promoting the use of the euro.

Steps Needed to Introduce a Common Currency
Economic cooperation is an integrated process. To achieve economic integration such as introduction of common currency, a certain level of integration is necessary. Otherwise it will never be possible to introduce a common currency in any such region. Before economic integration there are  levels of cooperation exists. In the following they are described in brief:
South Asia will have to wait for at least a few decades to make Vajpayee’s dream of common currency come true. Regional economic integration is a long process and can be broadly divided into two phases,

  1. Shallow integration and
  2. Deep integration.

The first stage of shallow integration is included-

The formation of Preferential Trading Area (PTA). In this stage trading partners offer preferential tariff to each other. SAARC Preferential Trading Arrangement came into existence in 1995 and at present members have reduced tariff on more than 6,500 products. This, however, has not resulted in a substantial increase in intra-regional trade because the reduction on tariff is not significant and the products on which reduction have been offered are not those that have high trade potential for other members.

The formation of Free Trade Area(FTA). In this stage members remove all tariff and non-tariff barriers among themselves but are free to fix their own tariff rates on imports from non-members. Architects of regional integration in South Asia envisioned having SAARC Free Trade Agreement (SAFTA) by the end of 2002. This though could not be achieved and now the officials are working hard to finalise the draft in the forthcoming twelfth SAARC Summit in Islamabad. The eleventh SAARC Summit held in Kathmandu in 2002 had proposed various dates for moving towards the establishment of an economic community in South Asia. It proposes that the least developed members remove all tariff and non-tariff barriers by 2010 and other members by 2008 so that SAFTA will be fully established by 2010.

The formation of a Customs Union. In this stage members, in addition to removing all tariff and not-tariff barriers among themselves, also set a common level of tariff for non-members. The architects of regional integration in South Asia envision having a South Asian Customs Union by 2015.

The first step of deep integration –

the formation of a common market. This stage is characterized by the harmonization of some institutional arrangements and commercial and financial laws. In addition to the free movement of goods and services, a common market will also have free movement of capital and labor.

The final stage of regional integration is the formation of an Economic Union. This stage involves the integration of national economic policies including tax and a common currency. The eleventh SAARC Summit held in Kathmandu in 2002 proposed that measures to establish South Asian Economic Union (SAEU) be completed by 2020.

Regional integration in South Asia is still in the first stage and its entry into the second stage is proving difficult. This was evident from the failure of officials to finalize SAFTA draft before the twelfth SAARC Summit to be held in Islamabad from 4-6 January 2004. Given the fact that the performance in the first stage has not been encouraging, it is questionable whether the dates proposed by the eleventh SAARC Summit in Kathmandu for various stages of economic integration within South Asia will be realized. In this light, Prime Minister Vajpayee’s proposal has taken many by surprise.

Rationale behind Common Currency
In this report we are trying to develop a hypothesis. This hypothesis we are callings the rationale behind economic cooperation that is introducing a common currency. The introduction of common currency will be beneficial up to highest point if there is interdependency between the member countries that are going for a common currency. For example the inter trade among the European Union countries was a significant amount. For this reason the transaction cost of converting currencies was huge. Since they were heavily independent and the inter trade cost them a lot, they went for introducing a common currency.
So if we can show that there is great deal of interdependence among the South Asian countries then, it can be viable basis for introducing a common currency. In the following, a statistics is given in percentage terms of inter trade among the South Asian nations. In the following statistics India is considered to be the base country. Then we have tried to compare that how much each of the other six countries is dependent on India in terms of Trade.

Economic indicator: Trade
Table 01: Inter regional export (Major partners)

The above table shows the percentage figures of inter regional export of South Asia. The blank space indicates either insignificant export or no export relationship with ”the countries. From the table it is evident that 35.55% of Bhutan’s total export is to India. Similarly Nepal exports 54.4% of its total export to India. Sri Lanka on the other hand exports only 7.2% to India. Maldives export 13.4% of its total export to Sri Lanka. Bangladesh and Pakistan have no significant export trade relationship with any of the South Asian countries.
Table 02: Inter regional import (Major Partners)

The above table shows inter regional import trade relationship. From the table it is evident that except Pakistan, all the countries have import relationship with India and they are quite significant. Bangladesh imports 14.70% of its total import from India and in fact India is the highest import partner of Bangladesh. Same thing goes for most of the countries.
So from the above two tables it is evident that though all the countries are not that much dependent to each other in terms of export, they are very much dependent on India terms of import. Since these countries are importing significant amount from India, it involves a transaction cost during currency conversion. So if a common currency can be introduced then, this transaction cost of currency convertibility can be eliminated and all the member countries will be benefited. A rough guide to the significance of these purported economic benefits is provided by the importance of intra-SAARC trade in relation to the total trade of SAARC countries.
This ratio has hovered in the range of only 4-5 per cent over the past decade, despite SAFTA and various bilateral free trade agreements among SAARC countries.
Contrast this low number with 50 per cent plus for the North American Free Trade Agreement and 20 per cent plus for ASEAN. (Incidentally, there isn’t much impetus for a common currency in even these more successful regional trading arrangements.)
Furthermore, intra-SAARC cross-border flows of capital are even less significant in relation to total investment flows into SAARC nations. Therefore, as a first approximation, it is clear that the benefits from a common currency are likely to be modest for SAARC members.

Comparative Analysis of Economic Indicators
The inflation rate of the South Asian countries is quite unstable. The rate has been 1994-2003 significantly. Instead of being members of a common region, their inflation rates do not follow the similar trend. The only exception is India where the inflation rate is almost stable for the last five years. No wonder, India has the highest GDP among the SAARC countries, as it possesses the largest population as well as largest’ country size and resources. The GDP growth rate of the seven SAARC countries during the period 1994 – 2003 lacks steadiness. Although, India and Bhutan show a stable growth rate in GDP, other countries suffer from significant fluctuations. Specially, Nepal and Sri Lanka had an experience’ of negative growth rate and Pakistan had its least growth of 1.0% in 1997 from 4.8% in 1996.

All the seven SAARC countries have trade deficit. Taking the individual country size, population and the deficit trade amount under consideration, we see that Pakistan has shown a better performance in the last few years of that period. Obviously India and Bhutan have the largest and lowest trade deficit respectively because of their population size.
The foreign reserve amount of India has a steady growth since 1994. India experienced a sharp increase in reserve fund from 2002. Opposite scenario is found for Sri Lanka. It had a decreasing trend from the year 1994 to 2000, and afterwards the reserve has been increasing gradually. Pakistan had a very much fluctuating reserve condition up to the yea- 2000. Then it has started increase its reserve significantly. Bangladesh had its best reserve in 1994 and then reserve went through some fluctuations up to 2001. Since then, Bangladesh has been increasing its reserve amount.
At the end, by observing all the relevant economical features of the seven SAARC counties, we can come to a conclusion that these countries lack homogeneity. They differ from each other at a large scale in terms of inflation rate, GDP growth rate, trade balance and foreign exchange reserve.

Benefits of a Common Currency
The common currency regime, when achieved, can present substantial benefits to the region. With uncertainty about exchange rates removed, and transaction costs reduced trade and investment in the region can get a big boost. Also with money creation under regional guidelines, there would be better prospects of synchronization of inflation, interest rates and GDP growth, all of which can contribute to accelerated growth and poverty reduction. In fact, a common currency regime can eventually play an important role in convergence towards a target of 7-8 per cent per annual GDP growth for all countries of the region, which is essential. South Asia could benefit most if a common currency is instituted for the whole region. The benefits could be:
** Reduction in transaction costs across the frontiers. In fact, conversion of one currency to another involves costs that increase the production and distribution costs.
** Facilitating the movement of scientific and technical manpower among member nations, as conversion losses will be neutralized.
** As the conversion costs are eliminated, a common currency could play a major role in reducing informal trade. If free trade is permitted in the region, much of this informal trade could be translated into formal trade that, in turn, could earn valuable revenue for the governments.
** Pre-empting a South Asian Central Bank, which will facilitate further economic integration.

Disadvantage of Common currency & Impediments to Economic Union
The biggest disadvantage of economic integration is that there has to be a regional central bank and that bank will be the sole authority in making regional monetary policies. Like the European Central Bank, a similar South Asian Central Bank has to be created in odder to supervise the common currency. Now this means individual countries cannot make their own monetary policies. This is where the problem begins. The considerations, of sovereignty have traditionally weighed heavily on South-Asian Countries. They have been averse to surrendering their decision-making powers on a wide range of issues.
Collective decision-making is a slow affair in the SAARC network. Even matters of vital importance lie in balance for decades without any decision being made. The issues of the creation of SAPTA and SAFTA are good instances. The creation of both would have enabled all countries of the region derive vital producer and consumer surpluses. But decisions on this issue have been notoriously slow.
Another awkward block is the peculiar geography of the region. India is bigger than all the other countries of the region put together. This has driven the smaller countries to believe that India is the ‘dominant big brother’. Consequently, any meaningful effort on India’s part is looked upon with suspicion.
This region also lacks in homogeneity in terms of economic variables like inflation, GDP growth rate and some other. This lacking in homogeneity is a big impediment in introducing common currency. South Asia is also weighed down by its weak economic fundamentals. For the creation of the monetary union, controlling inflation within a fixed range is a pre-requisite. But in the South-Asian region, different countries are at different levels of economic development.
As for economic costs arising from the loss of policy autonomy, the literature on ‘optimum currency area’ indicates that such costs are likely to be higher to the extent that business cycles across member states are not synchronized and to the extent that member nations are subject to different (in time and degree) shocks, to which their economies have to adjust.
The huge economic costs recently suffered by Argentina at the collapse of its unsustainable currency board system (a weaker version of a common currency with the US) should offer some warning to armchair proponents of currency union for SAARC.
Recent econometric studies by Maskay (e.g. in South Asia Economic Journal, 2001) and others have shown that there has been no significant synchronization of economic cycles (as reflected in trends in GDP growth and inflation) among SAARC countries during 1980-2000.
What this means is that the monetary authorities in each SAARC country had to contend with rather different business cycle conditions at any given point in time.
Conversely, any uniform monetary and exchange rate policy imposed by a regional SAARC central bank would not have been in the interests of individual member countries.
These studies also suggest that the pattern of exogenous political and climatic ‘shocks’ experienced by SAARC countries was quite diverse, despite some emerging trends of convergence in trade and exchange rate liberalization.
Overall, the empirical studies point to substantial divergence in the pattern of business cycles and shocks across SAARC countries. This, in turn, means that SAARC countries are better off retaining the freedom of policy action available with separate central banks and independent monetary and exchange rate policies.

Present Political Problems in South Asia

Intra-state conflicts
There is no single factor as main cause of conflict in South Asia. It involves many issues and provides a disappointing picture in every social, economic and political context. This is due to the fact that South Asia is almost perpetually burdened by various inter and intra-state conflicts and crisis stemming from the careless approach of the ruling forces toward resolution of such problems which are based on narrow considerations of caste, religion, ethnicity, language, community, and the like. This distorts the, national integrity and the overall law and order situation of the affected states.
Furthermore, South Asia is an area of tremendous political complexities. States: like Pakistan have been largely ruled by authoritarian military rulers. India, as such faces several unresolved issues that stem from internal as well as external sources These include ethnicity, border disputes, separatist demands, terrorism and subversive activities, communalism, religious problems and so on.
In Nepal, for example, the series of democratically elected government failed to produce any better result than the old royal regime due to widespread corruption and crisis of good governance. The political fundamentalists such as Maoists and mainstream political parties are posing major threat to democracy in Nepal. In addition to creating law and order problems, increased human rights violations and a heavy reliance on security forces have undermined the question of legitimacy of governance in Nepal. Moreover, the problem of civil violence in recent years has emerged as a more serious security issue than the problem of inter-state warfare in South Asia. India has been variously preoccupied with separatists and religious conflicts such as in the state of Punjab and Kashmir, an issue that remains controversial between India and Pakistan. Also the conflict with separatists of Mizoram, Assam, and Nagaland (Eastern India) for autonomy and in Gujarat, Mumbai and other parts have certain religious, ethnic, psychological and economic underpinnings.
Sri Lanka has also had its own set of problems. Democracy in this tiny island-nation remains overshadowed by the civil war originating from Tamil-Singhalese ethnic conflicts. These conflicts in Sri Lanka have pushed successive governments on the edge of collapse. Ruling parties in Sri Lanka failed to reform economic policies due to polarized political debate. In Pakistan, the society faces periodic bursts of violence derived from ethnic, sectarian and religious differences in its diverse community. For instance, conflict in the Sindh province between ethnic Sindhis and those residents who migrated from India following partition has made the province, especially its capital Karachi, ungovernable. Conservative religious elements are also very powerful in Pakistan leading to tensions and conflicts over religious differences, which has also played a major role in sustaining the Indo-Pakistan disagreement over Kashmir. Religious fundamentalism is also evident in Bangladeshi society manifesting itself in attacks on cultural groups, judges, prominent non-governmental organizations (Bangladesh Rural Advancement Committee and the Grameen Bank). Recent series of bomb blasts in Bangladesh are the evidence of fundamentalism which terrorized the whole nation.
Similarly Bhutan and Maldives – the two smallest members of the SAARC also have their own arrays of internal problems. The emerging internal political problems in Bhutan and the fallout of attempted coup in Maldives in 1987 have varying affects in uniting` the country for the cause of development. All this can largely be attributed to the fact, that political and governing institutions in most of the South Asian countries are weak while the political parties themselves lack strength, organization, discipline, and commitments. Taken individually, each of the South Asian states suffer from some kind of instability and consequently projects varying intensities of human deprivation.

South Asia is one of the critical regions with complex security in the world primarily due to the fact that most of the South Asian states are engulfed with varying degrees of conflicts and disputes. Inter-state conflicts in South Asia probably are highest compared to any other regional blocs. Bilateral relations are defined by hostility and mistrust. The differences between India and Pakistan over Kashmir, between Sri Lanka and India; over the nationality of Tamilian, where Sri Lanka accused India, especially state government of Tamil Nadu for supplying arms and providing trainings to the Tamil terrorists in its Southern areas are only two of the most outstanding examples in this regard. Dispute exists between India and Bangladesh over illegal migration from the Chittagong Hill Tracts (CHT) and the demarcation of boundaries involving fertile islands and enclaves and also in sharing the water of river Ganges. Recently when a series of bomb blasts occurred in Mumbai, India directly accused Pakistan and Bangladesh for facilitating; the attack.
The most pronounced security dilemma, however, stems from escalating arms race in South Asia, particularly between the two military powers – India and Pakistan. These disputes among countries further complicate the scenario and have created a lot of problems among the leaders for friendly talks.
Similarly the cultural diversity based in languages, religions and ethnicities is another factor that disables the region to unite. Rather it frequently exerts a negative impact on inter-sate relations in South Asia due to religious differences. Countries with widely differing political systems -A Common Currency in SAARC Countries 75 democracies, military dictatorships and monarchies, characterize the area. Though most of the South Asian states have emerged with shared colonial pasts, similar political experiences, common social values divergences, however, are still significant. India and Sri Lanka are said to have performed better than other functioning democracies with varying degrees of success. Pakistan and Bangladesh at the beginning of the 1990s witnessed a sweeping democratic transition in their domestic scenarios. Nepal’s transition to democracy is at the crossroad following the Maoist movement. Bhutan retains the authority of monarch as the dominant institution while the Maldives has yet to experience multiparty political systems. The troubles in South Asia, its widespread tensions, mutual distrust and occasional hostilities are largely considered products of the contradictions of India’s security perception with that of the rest of the countries of the area. India’s neighbors perceive threats to their security coming primarily from India whereas India considers neighbors as an integral part of its own security system. The supremacy of India in the South Asian power configuration given its geography, demography, economics, and ecology is something about which neither India nor its neighbors can do nothing but accept. But, the image of India in South Asia is that of a power that demands habitual obedience from its neighbors. Thus, the main theme of this doctrine is that South Asia is to be regarded as an Indian backyard. No wonder then, that there has always been certain psychological doubt on the part of the smaller states about their all-powerful neighbor India.

Corruption legalization
The term corruption legalization indicates to the making good of bad and legalizing of illegal, and allowing of forbidden things. Now a day it is most complex and controversial topic especially for researchers and criticizers. In context of Bangladesh the implementation of corruption legalization may lead the economy to a divested situation rather than bringing advantages. To legalize corruption we have to define the term of corruption at first.
Under this concept, all negative must be positive in a systematic way, so that negative things get reduction with negative things.
Definition of Corruption
Corruption is not just an economic exchange, generated by a monetary or ‘economic’ motive. Neither is corruption an exclusively political activity, motivated by a desire to attain or retain political power. The process of corruption is more than economic or political – it is a social process as well, existing side-by-side with, and sometimes complementing economic and political activity.
There are several meanings of the word corruption but when we use the term we usually refer to a specific kind of exchange, activity or behavior. For instance, corruption could mean a process of physical decay or degeneration; the loss of innocence; a state of moral impurity or moral deterioration; perversion in taste or language; and also the wrongful, negligent or willfully corrupt act of a public official in the discharge of his or her public duties. Even though corruption manifests itself as a force on its own and often generates its own momentum, it is linked to many other factors, and it is by understanding these factors that we can hope to understand corruption.
 ‘The misuse of public power for private profit’, it is this specific definition of corruption.
Causes of corruption
The causes of corruption divide into three categories, cultural, psychological, and system-related.

Cultural factors: “In many countries certain types of corruption are more or less acceptable often depending on the scale in the traditional, political culture.” Some countries have more of a reputation for corruption particularly because of traditional attitudes towards family, kinship, etc.
The other cultural factor is a weak tradition of the rule of law and low level of respect for the law.

Psychological factors: There are a number of psychological factors that help to explain some types of corruption. Taking into account the internal factors of individuals some individuals are “naturally evil” and will commit criminal acts, including corruptones in any type of system. The external factors, individual’s relationship to the group is also important. According to Holmes (1993, p. 165) “the power of both peer pressure and peer-comparison can be great, for instance in the words of one artist “when the best of people take bribes, isn’t it the fool who doesn’t?” In other words if individuals see others around them benefiting from corruption, they may well choose to indulge too.” a position that can take bribes and don’t use their chance they will be considered by their coworkers as stupid men. So under the pressure of this factor many public officials during some period of time become corrupted. But in many cases because people choose their new job depending on the scale of opportunity for taking bribes and they know they should take bribe because this is the way of life.

According to Holmes (1993) “nepotism also as a form of corruption can be explained in
psychological term. “The blood is thicker than water” syndrome wanting to help one’s family. Nepotism can be explained in terms of individuals seeking to maximize their own power and the lust for power is a psychological variable.”

Human weakness: also may cause corruption. Some people find it difficult to reject offers from a person of a “generous” nature. Some officials will accept gifts because they know they are particularly helpful to someone and either feels they “deserve” a reward (that is they feel that a reward is not inappropriate), or else genuinely do not want to offend or embarrass a grateful supplicant.

System related factors: One way in which this occurs is trough the Privatization of services and industries that had once been run by the state. The poor drafting of laws and regulations also creates many opportunities for corrupt acts
Impact of Corruption
The moral impact of corruptions acts, especially when committed by the state. Although there is considerable debate about the causes of corruption, and also about the manner in which corruption manifests itself, there can be no denying the negative impact of corruption.
Developed and Developing World
It seems difficult to get away from the impression, therefore, that the industrialized countries of the North possess a ‘cleaner’ policy.  A brief survey of the industrialized world demonstrates that far from being absent, corruption is both present and frequently disguised in the policy. We cannot assume that there is no corruption in the developed world. The distribution of public resources according to personal criteria, and/or the appropriation of public resources for private ends, appears to be normal among dominant groups in industrial societies. Here it is generally acknowledged that patronage plays a major role in the recruitment and cohesion of dominant political and economic elites. In the United Kingdom, for instance, it extends from the extensive kinship and friendship connections which closely connect members of the ruling classes or the ‘establishment’, to the regular dispensation of patronage by the ruling party through a well developed reward system. There is a distinct impression that developed societies have a ‘clean’ policy and developing societies do not.
There are two major reasons for this perception.
First, a close examination of the developed societies reveals that by far and large, there is little or no evidence of corruption in the visible, widespread, day-to-day, petty and routine aspects of public administration. In these societies, corruption exists in the upper, less visible, more exclusive domain of the rich, wealthy, senior members of government, bureaucracy and civil society.
In developing societies, on the other hand, corruption is not restricted to an exclusive elite network alone but extends to different levels of socio-economic and political activity. Corruption in these societies prevails at virtually every point of contact between the state and the market, or the public with the private. In Bangladesh, for instance, as has already been stated, there is ample evidence to show that corruption is not the exception to the rule. It is found at virtually every level of activity in which the state plays a role – from the national, political level to the far-flung rural level. Corruption permeates not only the relatively higher, politically sensitive, and sensitive aspects of state activity, but also its routine functions and structures. There is ‘more’ abuse of the public office in the developing world.
The second reason for the perception that developing countries are ‘more’ corrupt is modernization.
Modernization and Corruption: In this hypothesis, ‘modernization’ is offered as the ultimate goal of all civilized societies. Through this world-view, the developed world appears to display all the characteristics of a ‘modern’, ‘advanced’, socio-economic and political system. In dramatic contrast to this, ‘modernization’ seems to be absent in the developing world. Here, poverty and economic deprivation are linked inexorably to’ backwardness’ in social, economic and political organization.
Modernization cannot resolve the problematic inherent in the rational-legal ideal of bureaucratic transparency, nor can it account for the reality of patrimonial forms of organization in the developed countries. Furthermore, it cannot satisfactorily explain why, when the developed societies and states do come under socio-economic pressure, they tend to become as ‘soft’ as their counterparts in the developing world – the presence of large, immigrant, so-called ‘ethnic’, or socio-economically challenged communities, living on the margins of ‘civic’ life in the developed world, is a case in point and worth noting . We might also remember that public administration in the developing world is regarded to be ‘clean’ because it has seldom been tested – at base, it is a fragile system, prone to abuse and misuse, just like any other system.

Corruption and legalization – in perspective of Bangladesh
Corruption is a topic of most interest and concern in academic circles, in the media, among people of different professions, within the civil service, among members of parliament, politicians, government officials, members of the business and financial communities, students, foreign investors, aid agencies and non-governmental organizations. In other words, the term corruption is not new to Bangladesh. A survey found, among other significant data, that 95 per cent of respondents believed that the police were the most corrupt department in the land, followed very closely by the customs, the department of excise and taxation, the bureaucracy, and the judiciary. A solid 62 per cent of respondents believed that the primary responsibility for corruption in Bangladesh lay in the hands of government officials.
As a social process, therefore, corruption is everywhere in Bangladesh. It is present, for instance, in the process of political patronage, and/or the socio-political institutional arrangement called a patron-client relationship, through which public resources are appropriated by a select group of people, usually described as elites; it is visible in economic exchanges such as the process of rent-seeking which (regulatory requirements by) public servants impose on players in the market: also known as ghoosh or bribe; it is visible and invisible in a host of activities which range from outright bribery to more subtle forms of patronage or persuasion such as tadbir, from underhand deals involving vast sums of money at the national and international levels, to petty, everyday baksheesh which the doorman at a bureaucrat’s office extracts in order to perform his normal duties.
Most corrupted Spheres and Impact of corruption legalization in context of Bangladesh
True, there are arguments which claim that, under certain circumstances, corruption can be beneficial in oiling the wheels of a rigid, over-regulated economy, in providing a safety-valve from repressive regimes, in overcoming delays caused by administrative hurdles and even in personalizing what would otherwise have been an impersonal and uncaring distribution system.
Similarly, it is argued that in the developing world, corruption legalization is a form of indirect taxation which, if removed, would cause bottlenecks which would prevent the smooth functioning of government and business. Furthermore, analysts argue against the assertion that corruption is a waste of resources. They point out the fallacy in the assumption that resources ‘diverted’ into graft would otherwise have been spent productively, or redistributed to the poor, claiming that resources ‘saved’ from graft would most likely be spent on luxury items, not on development projects. In other words, in a situation of chronic scarcity which is what exists in the developing world, there would be other ways in which income inequities would be maintained.
There are several, most corrupted scopes in Bangladesh. If corruption is legalized then there may be miscellaneous effects. These are following —
Administration: the most and largest corrupted sector. It is true that under certain circumstances, corruption can provide some instrumental advantages. It is possible that without corruption, administration in many parts of Bangladesh would – at least temporarily – be impeded. It is also undoubtedly true that under certain conditions, corruption lends a humanizing aspect to what may otherwise have been an impersonal and rigid exchange. For the legalization the activities may be speedy but it would be very costly for a poor doing any tusk.
Business & trade: In economic terms there is no difference between illicit and licit goods indeed, as an economic exchange; corruption often stabilizes the business environment, functioning as an important medium through which the logic of the market asserts itself. Arguments in support of corruption can be applied to many developing societies, where a large bureaucracy is usually so extended and inefficient, that business and trade can only function with the aid of consistent corruption. In Bangladesh, certainly, although corruption is seen to be a serious problem, it is also evident. The distinct impression that without corruption, business would be paralyzed.
Granted that in the absence of exchanges which make the bureaucracy ‘flexible’, much activity in Bangladesh would come to a halt. But surely the illicit exchange, or the bribe, itself, is not the problem. It is extremely important to realize that the ‘benefits’ of corruption are, in all likelihood, masking symptoms of a seriously dysfunctional socio-economic or political system. It is more than likely that corruption has emerged because of other, hidden or deep-seated problems or, as is often the case in the developing world, corruption flourishes because structures have been imposed on people without due consideration of their applicability in these environments.
If it is legalized then it appears to be considerably less acceptable when the state is corrupt. This is partly because the state presumes upon the membership and loyalty of its citizens – something which a private body does not (cannot) assume. Consequently, because the state has a special position, and is regarded to be a neutral, impartial, and representative body which will provide for and protect the rights of the people, any perversion of this understanding is regarded to be far more serious than if the same act were carried out by a private body. The purchase of favors is nothing but an implement ring, speedy& productive exercise.
The effect of legalizing corruption on economic and political development:
As the world is diving into corruption and no one cannot avoid it in spite of imposing strict law and religious value. In this situation we can say that legal corruption is better than illegal corruption. Committing corruption is another basic human right under threat. Anticorruption turns to a culture in our society. To succeed in combating corruption, it is not enough that people should fear the law and punishment; they must also be ethical and poses the ethos that makes corruption fail to thrive.
To measure economic development we have some units and scale but to measure development in politics however, there is agreement neither on the units nor on a single scale to measure development. Political development cannot be defined only by one definition. According to many authors political development has various definitions. For example, it has been defined as administrative and legal development, democratic development etc.
J.S.Nye (1996) refers the term “political Development” to the governmental structure and processes to social change. We generally assume that this means structures and processes, which are regarded as legitimate by relevant sectors of the population and effective in producing outputs desired by relevant sectors of the population. So political development according to Nye (1996) means the growth in the capacity of a society’s governmental structures and processes to maintain their legitimacy over time.
Although the term “corruption” generally has a negative connotation, it according to many
Authors can in some circumstances be a distinctly beneficial phenomenon. For example
Nathaniel Nathaniel Leff’s (1964) article “Economic Development through Bureaucratic Corruption” is the most frequently cited source for the argument that “corruption in the form of bribing can be an important arm in the hands of entrepreneurs seeking to do business with a hostile or indifferent government and may, indeed stimulate the development process.”

According to Leff (1964) in many developing countries excessive bureaucratic control and regulations creates serious uncertainty for entrepreneurs. So the bribery can help bureaucrats to get around excessive regulations and minimize uncertainty over enforcement. Then Leff see corruption as a auction mechanism where the most efficient firm will be able to pay the highest bribe for government single license or permit. In addition some authors argued that bribery could enhance efficiency by cutting the considerable time needed to process permits and paperwork.
“speed money” argument by showing a positive relationship between the extent of bribery and the amount of time that enterprise managers spend with public official. Bribing also tend to spend a greater share of management time with bureaucrats and public officials negotiating licenses, permits, signatures, and taxes.
Advantages of legalizing corruption
This term is the most controversial topic that requires various opinions and disputes.It seems to be impossible and satire matter for general people and criticizers. Although it has huge bad impacts it is also beneficiary for the society giving equal right for corruption in the opinion of watchdogs and analysts.

  • Human beings have the tendency of enjoying and engaging in forbidden and illegal activities. If the corruption is turned to legal phenomena the repetition or practicing corruption may compelled to reduce or eradicated.
  • No single one be affected to the curse of corruption.
  • Committing corruption is another basic human right under threat. Anticorruption turns to a culture in our society.
  • The corruption will be no more the matter of threats for specific people.
Disadvantages of corruption legalization
The bad side of corruption legalization cannot be explained in a word. It may affect all sectors and compel to a devastating situation.
  • May lead all people to be engaged in illegal corruption.
  • General movement of official task and job may be hampered
  • Economic growth and expansion compelled to be slow down
  • The number of corrupted people may increase in several folds as well as the corrupting affairs tend to cloud the world.
  • As everybody had the power and right of corrupting so they can misuse it for personal interest and jealous.
  • The extremist tendency regarding committing corruption may hamper the normal activities and behavior.
According to many authors’ investigations the excessive tolerance of corruption can have serious negative effects on economic and political development. According to John L. Mikesell (1995 p.65) “Not only is the budget a financial accounting of the receipts and expenditures of the government, it also sets forth a plan for allocating resources – between public and private sectors and within the public sector – to meet national objectives. Budget preparation, discussion, and improvement thus must be at the hearth of public decision making.” Even in a market economy, the budget represents the basic national economic plan, the chosen mix of public and private sector use of national resources. So in presenting the negative effects of corruption on economic and political development we would like to begin from the fact that corruption tends to shift government spending away from the social areas towards the construction of unneeded projects or lower quality investments in infrastructure. In most corrupted countries, corrupt politicians tend to choose investment projects not on the bases of their intrinsic economic worth, but on the opportunity for bribes and kickbacks these projects presents. Vito Tanzi (1995) for properly addressing corruption in public spending makes a distinction between political or high level and administrative or bureaucratic corruption. Political corruption takes place when political decisions are made about the budget; the administrative corruption takes place during the budget execution. Political corruption has particularly damaging effects on the allocation of resources because it tends to divert resources away from the function to which they would have been allocated in the absence of corruption. Tanzi and Davoodi (1997 p.10) found that “corruption tends to be associated with higher public investment and high corruptions tends to reduce Government revenue, which in its place reduces the resources available to finance spending, including public investment.” High corruption also tends to be associated with poor quality of infrastructure, this reduce its contribution to output. Large-scale corruption indeed has powerful effects on both the quality and the quantity of public investment. Because most current spending by governments reflects entitlements or previous commitments such as pensions, interest payments on public debt, salaries, and subsidies politicians have, in short run limited discretion to influence it. In contrast, there is nothing routine about the capital investment and its composition. Capital spending is highly discretionary. In formulating the capital investments, senior political figures must make the basic decisions. These decisions determine the size of the total public investment budget, the general composition of that budget, the choice of specific projects and their geographical location, and even the design of each project. Senior officials may have complete discretion over these decisions especially when a country’s controlling or auditing institutions are not well developed and institutional control are weak.
According to Tanzi (1995) “the widespread corruption in the investment budget will not only reduce the rate of return to new investment in a country, but will also affect the rate of return the country gets from its existing infrastructure.” As corruption has long been around the existing infrastructure has also been contaminated because past investments were administered or distorted by corruption. Moreover, higher spending on capital projects will reduce the resources available for other spending. Of other spending categories, one not protected by entitlements is operation and maintenance the current public spending required to keep the existing physical infrastructure in good working order. Too often, new projects are undertaken while the existing infrastructure is left to deteriorate. In cases of extreme corruption, the physical infrastructure will need to be rebuilt, thus allowing corrupt officials the opportunity to extract additional commissions from new investment projects. So corruption affects the development by reducing the efficiency of public investments directed it toward unneeded projects and during the long-term corruption it distracts the existing infrastructures which are also very important for political and economic development. Corruption not only affects the budget investments but also reduces the budget revenues, which is very crucial for further development. As we know corruption can lead to tax evasion and poor tax administration. The other effect of reduced revenue is the budget deficit. Corruption reduces State revenues, which in its place raise the budget deficit.

According to Miksell(1995 p ?) “The effects of continuing large budget deficits are expected to be largely long term. First international capital market effects promise to reduce standards of living. Second federal deficits threaten long-term economic growth in the national saving may be used to finance investment or accommodate government deficits. Given the overall saving rate, the deficits absorbs savings that otherwise could have been productively invested. Third continuing large deficits leaves higher interest obligations in the future. Finally, to the extent the deficit remains a political issue it constrains the capacity to respond to legitimate national concerns. In a deficit dominated climate, the first reaction to any policy initiative, whether it is national healthcare reform, welfare reform is not whether a problem exists that the federal government might try to resolve but what the deficit impact of the response might be.” Another factor hampering growth and contributing to the expansion of the shadow economy is the bureaucratic red tape. “Shadow economy” in reality pay taxes which do not go to the pocket of the State but becomes fashionable houses or luxury cars for many public officials.
The prevalence of corruption arguably influences on the economic environment through the creation of significantly higher levels of risk and uncertainty in economic transactions.
Uncertainty is present both in the context of individual economic transactions and in terms of heightened fears about future developments in the broader economic environment in question. For business it is difficult to flourish in uncertain environment. Uncertainty with regard to domestic politics can reduce incentive for investment directly and through its impacts on government institutions Small entrepreneurs may be affected in many developing countries and transition economies.
Evidence from private sector assessments suggests that corruption increase the costs of doing business that small firms bear a disproportionately large share of these costs and that bribes can prevent firm from growing. Many businesses prefer to operate underground shutout the administrative approval processes by paying bribes because the regulatory and administrative requirements of starting and operating business involve extra documentation and fees. For example the process of registering can take months because registrations need to be obtained in a prescribed sequence, such that one cannot initiate all procedures simultaneously. So the costs of corruption and bureaucratic delays may price some potential new businesses out of market or drive them underground. Similarly the costs of compliance affect existing businesses through changing requirements, the need for regular recertification, and onerous record keeping requirements. Corruption can have a negative effect on foreign investment. For most foreign firms corruption is a cost of doing business to be recouped from revenues. If the costs become too high or unpredictable for corruption legalization, foreign firms will disengage. Or foreign investors may shun the country altogether. High levels of corruption add to the risk of a country being marginalized in the international economy. So uncertain environment, big bureaucratic red tape, and poor tax and custom administration reduce not only domestic investments but also Foreign Direct Investments (FDI) which is very crucial factor for economic development for any country.
Corruption can affect on human capital formation, which is the most important input in the process of production and transformation that is called economic development. Corruption also will likely decrease the effectiveness of aid flows, which could have negative effects on the development.

Legal corruption is better than illegal corruption

Now whether they pay openly or on the sly, companies (or individuals or unions for that matter) are not doing it for high-minded purposes. They are doing it because they expect to influence their parties to implement the policies they favor. That is still corruption in my book. I don’t like it. My preferred solution is to reduce the powers of the government and restrict its ability to favor one section over the other.
But that is a long-term target that may take decades to achieve. In the interim, we would prefer it if the campaign contributions drama is played out in full view of the TV cameras rather than under the table, seen only Tehelka’s hidden camera. That way, we can keep tab of who is paying how much and who is influencing policy which way.
To distinguish this solution from the other innovative approaches we should keep thinking of to eliminate corruption, but which should be classified under “privatization”. For example, say that you wish to reduce corruption among Railway ticket examiners. Let’s say that they collect bribes instead of imposing fines and they make so much money collecting bribes that people pay bribes to become TTEs.
Here is a solution which will work on Mumbai’s local trains. Instead of recruiting TTEs, why not simply 1) auction off the posts to people(for an annual lump sum amount perhaps), 2) Pay them no salary and 3) Let the TTEs keep the fines they collect? The TTEs can be given the authority to levy fines up to a specified maximum with the freedom to collect less if they wish.
That way the railways can actually collect the money they lose when the TTEs collect bribes rather than fines. TTEs will have an incentive to be efficient (actually they it even now) Because the amount being paid to the railways is a legitimate payment, people can get bank loans for it, so poor people aren’t discriminated against.
It is just an example. It is probably a better idea to hand over this task to a private agency than auction posts the way we have discussed it. We just wanted to give an example of using the power of self-interest for good. The point also is that in the latter case, once the rules have been appropriately set up, “collecting bribes” is no longer wrong. In the former case, i.e campaign contributions, the contribution is still a bribe and hence wrong even when legal.
So that’s what is meant by “legalizing corruption”. The trouble is that we can’t think of other examples where we would go for this solution.
Recommendation for SAARC currency
The first and immediate step that can be taken is to introduce a parallel currency and utilize that instrument effectively to promote regional cooperation in trade and investment, which can eventually prepare the ground for a common currency.
The parallel currency will be fully convertible into any international currency and will be fully backed by reserve fund. It will be legal tender for cross country transactions within South Asia and will be increasingly used as unit of account for trade and investment transactions within the region. The issue of stability of the parallel currency will of course be important. However, it should benoted that relative values of currencies in South Asia in the last ten years have been more stable than those between the three major world currencies, US$, Euro and Yen which dominate the SDR.
South Asian countries can create a pool of foreign exchange reserves in an institution. Backed with these reserves, the parallel currency, equivalent of a multiple of basic reserves, can be created to be used for giving loans or buying bonds issued by South Asian governments or corporations as appropriate. The lending rates on these loans will be higher than the interest paid on reserves which will be higher than what most reserves banks in the region are getting today from their dollar reserves. As the parallel currency gets accepted the reserve fund can earn profits, which will be distributed among members as grants for development purposes. The principle of creation and utilization of SDRs1 for development purposes has been advocated by a long line of economists.
Provision of regional public goods and concessionary assistance for the lagging regions will help to build confidence in the region and facilitate bolder programmers such as open borders, labor mobility and common currency. The manner in which the bigger countries in Europe won the confidence of the smaller countries and helped to accelerate development of lagging will be a model for South Asia to learn from. The steps involved in the proposed process are:

 (a) Creation of a parallel currency and associated agreements for its stability,
 (b) Setting up of a reserve fund,
 (c) Funding of regional public goods to promote trade and investment,
 (d) Special and differential treatment of lagging parts of the region to help the convergence process in the region, and
 (e) Building of mutual trust and confidence among the partners in the region.
These steps will create conditions, which are usually necessary for a common currency area. SAARC Summit could take steps to set up a Working Group comprising of Central Bank Governors to evaluate; the feasibility of the proposal and take it forward.

Recommendation for corruption legalization
It is crucial to understand the terms of reference of corruption legalization in Bangladesh. Bangladesh is a developing country, and by definition, poor. The state and society both have to cope with severe socio-economic and political pressures, such as a chronic scarcity of resources, unpredictable political changes and needs associated, frequently, with post-colonial upheavals, as well as the intervention of outside influences which bring with them alien ideas and often alter the dynamics of the country. These circumstances, accompanied by wide disparities in income distribution and the needs of vast numbers of people who survive under conditions of extreme poverty, add special significance to the prevalence of corruption.
This is one reason so much attention is paid to corruption in the developing world. In a climate of chronic scarcity in which a majority of the population lives under severe economic and social pressures, corruption is seen as an unforgivable waste, a squandering of the national wealth – especially by political leaders and public servants who are expected to devote their lives for the betterment of their country. Consequently, the impact of corruption in a developing country like Bangladesh will continue to be emphasized.
As the part of disadvantages is greater than possible advantages of corruption legalization, it can not be better for Bangladesh. It would make the worst condition for poor people. So it should not be legalized at any thoughts.
In addition to in Bangladesh, corruption cannot be ‘absorbed’ – as it appears to be, in developed societies – because of three basic reasons. First, as explained above, because it is located within the existing socio-economic and political conditions of poverty and social cleavages. Second, corruption is also located within the overall discourse on the subject and this discourse discourages the understanding of any other intellectual framework as a rationale for social process and formation (in Bangladesh).

The formation of SAARC was a landmark step taken by the leaders of the region. The main rational behind was to develop a friendly environment through summit diplomacy where all nations could interact peacefully with each other, cultivate sustainable peace and promote mutual economic well being by harnessing available resources in the region through the process of economic integration. Nevertheless, after 20 years’ of establishment, neither South Asian nations have been able to push the process of integration into full swing nor the organization itself has become viable that could promote peace and harmony or prevent conflicts in the region. South Asia has emerged as a regional entity in the international political system with the creation of SAARC but it failed to strengthen regional cohesiveness. Regional cooperation in South Asia cannot be said to have evolved into a complete bloc in terms of regionalism and economic integration due mainly to the prevalence of conflict over the desire of peace and stability. Hence right at this moment, SAARC countries have to improve their relationships and attitudes towards each other and they need to take initiatives to eliminate the existing conflicts among them. In order to introduce a common currency in the region, economical homogeneity is the prime factor, which has some deficiencies in the SAARC countries. Any move towards introducing a common currency for SAARC countries in recent time will not be viable unless a good neighborly relationship and economic homogeneity in the region are achieved.
Monetary policy
Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.
Monetary policy is referred to as either being an expansionary policy, or a contra dictionary policy, where an expansionary policy increases the total supply of money in the economy, and a contra dictionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contra dictionary policy involves raising interest rates to combat inflation. Monetary policy is contrasted with fiscal policy, which refers to government borrowing, spending and taxation.


Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard.
A policy is referred to as contra dictionary if it reduces the size of the money supply or raises the interest rate.
Smooth operation of the financial system. An expansionary policy increases the size of the money supply, or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.
There are several monetary policy tools available to achieve these ends: increasing interest rates by fiat; reducing the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and, if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from fiscal policy.
Within almost all modern nations, special institutions (such as the Bank of England, the European Central Bank, Reserve Bank of India, the Federal Reserve System in the United States, the Bank of Japan, the Bank of Canada or the Reserve Bank of Australia) exist which have the task of executing the monetary policy and often independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the
Bangladesh Bank
Bangladesh Bank, the central bank of the country, was established as a body corporate vide the Bangladesh Bank Order, 1972 (P.O. No. 127 of 1972) with effect from 16th December, 1971. The general superintendence and direction of affairs and business of the Bank are entrusted to a nine member Board of Directors which consists of the Governor as chairman, a Deputy Governor, three senior government officials and four persons having experience and proven capacity in the fields of banking, trade, commerce, industry or agriculture – all nominated by the government. The board, which is the highest policy making body, meets at least six times a year and at least once every quarter under the chairmanship of the Governor. The Governor, appointed by the government as the chief executive officer, directs and controls all the affairs of the Bank on behalf of the Board.

The broad objectives of the Bank are:
a) To regulate the issue of the currency and the keeping of reserves;
b) To manage the monetary and credit system of Bangladesh with a view to stabilizing domestic monetary value;
c) To preserve the par value of the Bangladesh Taka;
d) To promote and maintain a high level of production, employment and real income in Bangladesh; and to foster growth and development of the country’s productive resources for the national interest
To uphold the vision and in pursuant with the Bangladesh Bank Order of 1972, Bangladesh Bank’s mission is to promote and maintain macroeconomic and price stability through:

Formulating and implementing appropriate monetary policy consistent with the country’s national development goals;
Pursuing prudent policies to ensure stable internal and external value of Taka;
Identifying policy priorities for implementation by the Government through assessing the transmission channels and the interactions of monetary policy with fiscal, exchange rate, and other macroeconomic policies and their impact on the economy;
Proposing necessary legislative measures to attain the central bank’s objectives and perform its functions including strategies and regulations for and supervision of banking companies and financial institutions with the aim to providing efficient financial intermediation and financial services to large, medium, small, and micro enterprises and to pro-poor activities ;
Promoting, regulating and ensuring a secure and efficient payment system, including the issue of Bank Notes;
Giving advice to the Government on the interaction of monetary policy with fiscal and exchange rate policies, on the impact of various policy measures on the economy;
Analyzing priority macroeconomic issues for policy advice and dissemination of information to attain the central bank’s social responsibility.
To this end, BB would ensure that it has the requisite human and infrastructural resources and build its capability to promote and ensure a robust and well-functioning financial sector. This mission statement pledges that the guiding philosophy of BB’s operations would be sound regulatory framework conducive to the operation of efficient market mechanism along with transparency and accountability, professionalism, ethical standards, adoption of modern technology in operational and decision making processes, and trust and respect in all relations. Periodic strategic planning would serve to identify the emerging challenges, key changes affecting BB’s internal and external environment and set its strategic guidelines, set priorities, promote improvements in management practices, and induce necessary changes in organizational culture.
To fulfill its mission, BB would undertake activities related to developing the national financial system and management of monetary, foreign exchange, and credit policies. The Bangladesh Bank’s core mission strategies cover both monetary policy and financial sector developments.

Monetary Policy Strategy of the Bangladesh Bank
In practice, all types of monetary policy involve modifying the amount of base currency in circulation. This process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called open market operations.
Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate.
A central bank can only operate a truly independent monetary policy when the exchange rate is floating. If the exchange rate is pegged or managed in any way, the central bank will have to purchase or sell foreign exchange. These transactions in foreign exchange will have an effect on the monetary base analogous to open market purchases and sales of government debt; if the central bank buys foreign exchange, the monetary base expands, and vice versa. But even in the case of a pure floating exchange rate, central banks and monetary authorities can at best “lean against the wind” in a world where capital is mobile.
Accordingly, the management of the exchange rate will influence domestic monetary conditions. To maintain its monetary policy target, the central bank will have to sterilize or offset its foreign exchange operations. For example, if a central bank buys foreign exchange (to counteract appreciation of the exchange rate), base money will increase. Therefore, to sterilize that increase, the central bank must also sell government debt to contract the monetary base by an equal amount. It follows that turbulent activity in foreign exchange markets can cause a central bank to lose control of domestic monetary policy when it is also managing the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals

Monetary Policy: Target Market Variable: Long Term Objective:
Inflation Targeting Interest rate on overnight debt A given rate of change in the CPI
Price Level Targeting Interest rate on overnight debt A specific CPI number
Monetary Aggregates The growth in money supply A given rate of change in the CPI
Fixed Exchange Rate The spot price of the currency The spot price of the currency
Gold Standard The spot price of gold Low inflation as measured by the gold price
Mixed Policy Usually interest rates Usually unemployment + CPI change
The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking the exact same variables (such as a harmonized consumer price index).

Inflation targeting

The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar.
The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee.
Changes to the interest rate target are made in response to various market indicators in an attempt to forecast economic trends and in so doing keep the market on track towards achieving the defined inflation target. The inflation targeting approach to monetary policy approach was pioneered in New Zealand.

Price level targeting

Price level targeting is similar to inflation targeting except that CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move.

Monetary aggregates

In the 1980s, several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit. This approach is also sometimes called monetarism.  While most monetary policy focuses on a price signal of one form or another, this approach is focused on monetary quantities.
 Fixed exchange rate
This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation.
Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export licenses, etc.). In this case there is a black market exchange rate where the currency trades at its market/unofficial rate.
Under a system of fixed-convertibility, currency is bought and sold by the central bank or monetary authority on a daily basis to achieve the target exchange rate. This target rate may be a fixed level or a fixed band within which the exchange rate may fluctuate until the monetary authority intervenes to buy or sell as necessary to maintain the exchange rate within the band Under dollarization, foreign currency (usually the US dollar, hence the term “dollarization”) is used freely as the medium of exchange either exclusively or in parallel with local currency.

Gold standard

The gold standard is a system in which the price of the national currency as measured in units of gold bars and is kept constant by the daily buying and selling of base currency to other countries and nationals. The selling of gold is very important for economic growth and stability.
The gold standard might be regarded as a special case of the “Fixed Exchange Rate” policy. And the gold price might be regarded as a special type of “Commodity Price Index”. Today this type of monetary policy is not used anywhere in the world although a form of gold standard was used widely across the world prior to 1971.

Tools of Monetary policy

Bangladesh Bank may use different types of methods to control money supply in market. The primary means of conducting monetary policy include: –
#- 1: Quantitive method: A general method to control money supply in market without notifications in objectives or uses of loan. These are –
Bank rates
The rate at which central bank gives loan to commercial banks, discounts bill to control interest and money supply in market. Bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control the money supply.
A central bank adjusts the supply of currency within national borders by adjusting the bank rate. When the central bank reduces the bank rate, it increases the attractiveness for commercial banks to borrow, thus increasing the money supply. When the central bank increases the bank rate, it decreases the attractiveness for commercial banks to borrow, consequently decreasing the money supply.

Reserve requirements

Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Bangladesh Bank changes the availability of loanable funds. This acts as a change in the money supply. Bangladesh banks typically do not change the reserve requirements often because it creates very volatile changes in the money supply due to the lending multiplier.
Open market operations
The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, company bonds, or foreign currencies. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually, the short term goal of open market operations is to achieve a specific short term interest rate target.
Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total amount of money circulating in the economy.  Bangladesh bank can use open market operations to change the monetary base. The Bangladesh bank would buy/sell bonds in exchange for hard currency. When the central bank disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base.
# – 2: Qualitative methods: The methods used by central bank for giving loans to achieve special goals in special sectors. It may work best in case where the quantitative methods can not perform well. The tools used under this method are –
Loan allocation
In many cases central bank follow the Loan allocating policy. As a result commercial banks can’t give loans desired. There are some restrictions imposed by central bank.
Direct punishment
If any commercial bank doesn’t follow the rules and regulations of central bank for giving loan, then the central bank may give any punishment to control loan. A system that may perform best where banks don’t follow rules randomly.
Moral suasion
Cajoling certain market players to achieve specified outcomes. Central bank inspires the commercial banks morally to achieve specific goals.
By this tool central bank notifies or informs people and commercial banks about the importance of loan controlling. In developed countries central bank use this method to control loan.
#-3: Differential methods: In this methods bank give loans in necessary sectors where it’s very important for loan supply. by this methods central bank control the customers habit of unnecessary. Tools under these methods are –
Allocation of loan in necessary sectors
Under this method Banks give loan in necessary sectors and never give to unnecessary sectors. So it is a good way to control money supply in market.
Control to food loan
Ordinary most general people take loan for food products. So central bank sometimes prohibits or gives condition to central banks in giving food loan. It can be said very active policy.
Mortgage control
Central bank controls mortgage loan by increasing or decreasing mortgage against loan .if mortgage increases then the customers will take less loan and vice versa.
Discount window lending
Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans or extending new loans, the monetary authority can directly change the size of the money supply.

Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. Bangladesh bank can set the discount rate, as well as achieve the desired funds by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. One cannot set independent targets for both the monetary base and the interest rate because they are both modified by a single tool — open market operations; one must choose which one to control. The monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the money supply.
Unconventional monetary policy
Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns about deflation or deflation is occurring, are referred to as unconventional monetary policy, and include negative interest rates and quantitative easing (printing money).
The Effectiveness of Monetary Policy
Economists debate the relevant measures of money supply. “Narrow” money supply or M1 is currency in circulation and the currency in easily accessed chequing and savings accounts. “Broader” money supply measures such as M2 and M3 include term deposits and even money market mutual funds. Economists debate the finer points of the implementation and effectiveness of monetary policy but one thing is obvious. At the extremes, monetary policy is a potent force. In countries such as the Russian Republic, Poland or Brazil where the printing presses run full tilt to pay for government operations, money supply is expanding rapidly and the currency becomes rapidly worthless compared to goods and services it can buy. Very high levels of inflation or “hyperinflation” are the result. With 30-40% monthly inflation rates, citizens buy hard goods as soon as they receive payment in the currency and those on fixed income have their investments rendered worthless.
At the other extreme, restrictive monetary policy has shown its effectiveness with considerable force. Germany, which experienced hyperinflation during the Weimar Republic and never forgot, has maintained a very stable monetary regime and resulting low levels of inflation. When Chairman Paul Volcker of the U.S. Federal Reserve applied the monetary brakes during the high inflation 1980s, the result was an economic downturn and a large drop in inflation. The Bank of Canada headed by John Crow, targeted 0-3% inflation in the early 1990s and curtailed economic activity to such an extent that Canada actually experienced negative inflation rates in several months for the first time since the 1930s.
Without much debate, the effectiveness of monetary policy, its timing and its eventual impacts on the economy are not obvious. That central banks attempt influence the economy through monetary is a given. In any event, insights into monetary policy are very important to the investor. The availability of money and credit are key considerations in the pricing of an investment.

Monetarist macroeconomists have sometimes advocated simply increasing the monetary supply at a low, constant rate, as the best way of maintaining low inflation and stable output growth. However, Therefore, monetary decisions today take into account a wider range of factors, such as:

Trends in Monetary Policy through Time Flow

  1. Unconventional monetary policy
Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns about deflation or deflation is occurring, are referred to as unconventional monetary policy, and include negative interest rates and quantitative easing (printing money).
  1. Modern Monetary Policy
Modern central banking dates back to the aftermath of great depression of the 1930s. Governments, led by the economic thinking of the great John Maynard Keynes, realized that collapsing money supply and credit availability greatly contributed to the savagery of this depression. This realization that money supply affected economic activity led to active government attempts to influence money supply through “monetary policy”. At this time, nations created central banks to establish “monetary authority”. This meant that rather than accepting whatever happened to money supply, they would actively try to influence the amount of money available. This would influence credit creation and the overall level of economic activity.
Modern monetary policy does not involve gold to a great extent. In 1968, the United States rescinded its promise to pay in gold and effectively removed itself from the “gold standard”. Since then, it has been the job of the Federal Reserve to control the amount of money and credit in the U.S. economy. I doing this, it wants to maintain the purchasing power of the U.S. dollar and its comparative worth to other currencies. This might sound easy, but it is a complex task in an information age where huge amounts of money travel in electronic signals in microseconds around the world.
Monetary policy objectives and framework
Both in developed and developing economies, monetary policies seek to maintain price stability underpinned by sustained stable output growth in the face of internal and external shocks that are faced from time to time. In developed economies with production factors at or close to full employment, monetary policies are formulated typically with the output gap (difference between the actual and the longer run potential output) in view; the policy stance is eased to provide stimulus at times of slowdown when actual output lags the longer run potential, and the stance is tightened to slow things down when the economy overheats with actual output running ahead of the sustainable longer run potential. Diagnosing and treating asset price bubbles symptomatic of overheating are major issues of current debate in monetary policy. For developing economies like Bangladesh with significant underemployment/under exploitation of production factors, stimulating higher growth is imperative for rapid reduction and eventual elimination of endemic poverty, and is therefore an overriding priority.
The primary objective of the Monetary Policy Strategy document is to outline the formulation and implementation of monetary policy of the Bangladesh Bank (BB), and to convey its assessment of the recent and the expected monetary and inflation developments to the stakeholders and the public at large. The Bangladesh Bank Order of 1972 outlines the main objectives of monetary policy in Bangladesh, which comprises the goals of achieving price stability, maintaining high levels of production, employment and economic growth.

The Policy Target(s)
In this backdrop it is necessary that the monetary policy framework (in terms of the goals, the instruments, and the analytic channels of transmission) be articulated for greater clarity and transparency benefiting both the policy makers as well as the stakeholders. A policy regime, where the goals are transparent and their achievement verifiable, directly adds to the credibility of the central bank. A major objective of this document is to delineate such a framework.
Most industrial economy monetary policy is run with the task of keeping watch on both the output gap (i.e., the deviation of actual output from its long-run equilibrium level) and the inflation gap, which is similarly defined. In contrast, however, the challenge in the developing world is how to augment the capacity output through both productivity growth as well as via the installation of additional capacity. Faster growth in most developing contexts is necessary to reduce (and eventually eliminate) endemic poverty. Available evidence suggests that a low inflation environment alone may not allow the country to reach the poverty and output growth targets envisioned in the National Strategy for Accelerated Poverty Reduction (NSAPR) document approved recently (Govt of Bangladesh, 2005). Hence the appropriate monetary policy strategy in the Bangladesh context would be to achieve the goal of price stability with the highest sustainable output growth. Any monetary stimulus to foster growth must keep in perspective the broader goal of macroeconomic stability, which is a prerequisite for future growth. Price stability would also encompass the stability of the currency regime. While fiscal policy too is relevant in addressing these goals and thus there is a need for policy coordination, monetary policy must play its due role. While leading central banks in the industrial world have increasingly adopted the unitary goal of fighting inflation, interestingly Blinder and Reis (2005) have recently argued that it in keeping with actual behavior of the Fed, it will make sense for the US Congress to augment the FRS mandate by enumerating (a) the promotion of price stability, (b) ensuring full employment, (c) supporting global economic and financial stability (so long as the latter may be targeted without prejudicing the first two goals) as the chief monetary policy goals. In broad terms therefore the latter view is consistent with the BB vision as enunciated above, albeit anchored along different perspectives

Inflation Target:
It is the general wisdom that monetary policy tools are of immediate potency in controlling inflation. However contemporary evidence amply illustrates that monetary policy cannot deal well with the inflationary impact of external shocks such as the recent international price of oil
and related energy products. Many central banks as a consequence focus on the core inflation, which is typically constructed by subtracting the most volatile components (e.g., food and energy prices, indirect taxes etc) from the consumer price index (CPI). Agreeing with the view that a suitable core inflation measure ought to be the central focus, say something between the non-food CPI and the usual CPI, the question is where should the inflation target be set in the Bangladesh context? Note however that numerical targeting of inflation is not common in the South Asian region, which in part may be due to the lack of confidence in the true extent of the relevant transmission processes. However, it is quite relevant to set an indicative target band that will be realizable over the medium term (say over the next 12-to-18 months’ time). Neither the analysis on the nexus between low inflation and growth, nor, the recent developing country
experience provides a firm clue as to where to target the rate of inflation (IMF, 2005). However, it is widely held that in order for inflation to remain stable, it ought to be predictable, which in turn is extremely hard to come about if the actual rate is high (relative to its recent history). Low inflation is also believed to be pro-poor, as they possess few real assets. At the same time, many argue that a very low inflation may have unintentional contractionary output effects and lead to a loss of seignior age revenue.

 Growth Target:
So long as Bangladesh remains within the NSAPR-PRGF framework, the growth target is already built in there. The latter are based on the medium term macroeconomic framework
(MTMF), which enshrines the mutual consistency of the monetary and fiscal policies of the nation. Annual updates of the growth and inflation targets, and hence the parameters of mutually consistent monetary and fiscal programs must be based on sound forecasts of the level of consumer demand, investment and the balance of payments (BOP). Only then can the subsequent design of the policy environment, and the requisite means for its implementation can be firmly grounded on reasoned hypotheses. One major constraint in this exercise is the current lack of timely data on macro indicators such as output, industrial employment, and investment. The central bank can play a major role by coordinating with other institutions (e.g., Bangladesh Bureau of Statistics, BBS, the Planning Commission and the Ministry of Finance) the on-going efforts to collect and process quarterly and monthly data on major macroeconomic variables

Conduct of Monetary Policy
Consequently the Bangladesh Bank puts greater reliance on monetary targeting focused on the reserve money (RM, consisting of currency in circulation and the balances of other banks with the Bangladesh Bank), and thus via the money multiplier, on broad money, i.e., M2, which is the sum of currency in circulation, demand deposits and time deposits. BB programs the required limit of monetary expansion, broad money in this case, based on estimates of GDP growth, CPI and changes in the income velocity of money.11 The simple relationship between broad and reserve money allows the latter to be used as an intermediate target, which is convenient since the policy instruments may directly target RM effectively. While the details of the instruments and modalities are described below, note that the essence of this approach is to routinely (indeed on a daily basis) monitor and influence the supply of liquidity in the private credit market that would be consistent with BB’s judgment of the inflation and GDP outlook. However, the success of this strategy squarely depends on a good understanding of the underlying inflationary process and the GDP forecast built into the target money stock growth.

Choice of the Monetary Instruments
Since monetary policy goals cannot be influenced directly, like most central banks BB uses a set of indirect instruments. As described above, the broad money (M) can be influenced indirectly by
changes in policy instruments that target and monitor the reserve money (RM) via the money multiplier (m). The primary mechanism employed for this purpose is the direct control of liquidity on a day-to-day basis achieved by the repo, reverse-repo and the weekly T-bill auctions. The latter instruments would in turn have an impact on the inter-bank call money rate for overnight transactions, which is the equivalent of the federal funds rate in the US. The cash reserve requirement ratio (CRR) and the statutory liquidity ratio (SLR) are effective means of announcing the monetary policy stance. As the time lag between policy actions and the eventual impact on goals is usually several quarters long, additional information variables such as foreign reserves, short-term interest rates, liquidity situation and domestic credit growth appear handy for policy makers to adapt and revise its policy measures if and as needed. No matter how sound is the monetary programs being pursued and its analytical base, the monetary authorities need to use their judgment deciding the future direction of the policy stance and communicate that rationale to the public.

Exchange Rate Management
Movement in the exchange rate has a direct effect on GDP and employment outlook especially through the export channel where the competitiveness of a country’s goods depends on the REER. A misaligned rate structure may also lead to resource misallocation in domestic production. Since the floating of the currency, the short-term currency management issue has come down to ensuring orderliness in the movement in the exchange rate due to temporary events. Toward this end, other than occasional direct intervention (buy/sell) in the currency market, the Bangladesh Bank also has in its toolkit the indirect instruments that can exert an influence on the par value of the currency. These relate to the control over liquidity via repo, reverse repo, and T-bill auctions. Over the longer run, however, the primary exchange rate issue has to do with the real value of the exchange rate, namely the real effective exchange rate (REER). Fortunately, however, the inflation adjusted par value of the national currency has held up well against its competitors and the pattern has been stable, even depreciating a little during the past two-to-three years. To illustrate, the REER index of the currency stood at nearly 100 in early 2003 (indicating no over-or-under valuation); it has fallen to 90 in the current quarter, which represents a 10-percent depreciation rendering national exports more attractive. In the event of a persistent misalignment that is not being corrected by the market, the instruments at the disposal of BB are same as noted above.

Monetary policy used by Bangladesh Bank during last five years

Bangladesh Bank
Monetary Policy Statement, January-June 2010.
January19, 2010
Introduction: This ninth issue of Bangladesh Bank’s (BB’s) half yearly Monetary Policy Statement (MPS) outlines the monetary policy stance to be followed in H2 FY10 in support of pursuits of attaining sustained high broad-based economic growth in the unfolding internal and global context, while containing inflation within tolerable moderate levels.

 Policy approaches and tools: BB’s monetary policies aim at maintaining price stability while permitting monetary expansion needed to support output growth at sustained high rate. The money stock growth-CPI inflation correlation holds fairly well (charts 1.1, 1.2) in Bangladesh economy characterized by significant extent of restrictions on capital transactions with the rest of the world. Based on this correlation, BB employs monetary targeting to influence CPI, drawing up monetary programs each financial year with target growth path for broad money (M2: currency in circulation plus bank deposits) that accommodates monetary expansion commensurate with the projected real GDP growth, inflation, and the likely change in income velocity of money (change in GDP/M2 ratio). Reserve Money (RM: currency in circulation plus balances of banks with BB) growth path is the operating target used by BB to influence the M2 growth path (the intermediate target), for this in turn to influence CPI, the final target. Growth paths of a host of other monetary aggregates/sub-aggregates on the asset and liability sides (e.g., domestic and foreign assets, credit to public and private sector, currency, time and demand deposits) are also monitored in the monetary program, to assess the growth supportiveness and inflationary impact of monetary growth.

 Macroeconomic outcome, outlook

Intra-year output growth estimates are unavailable for the Bangladesh economy; the foregoing Executive Summary has reviewed trends of available indicators of growth performance, in the nature of informed guesses, to find that (i) after a slower first quarter, manufacturing output and investment activities have picked up from Q2 FY 10 onwards with domestic demand holding up well and exports gradually coming out from declining trend, (ii) 0that agriculture sector output activities are responding robustly to market price incentives and the support measures provided by GOB and BB (Box), and (iii) that output activities in the services sector are also correspondingly vibrant; with the higher end of the 5.5-6.0 percent real GDP growth for FY10 projected in the July 09 MPS looking well within attainability.

Point-to-point and 12-month average CPI inflation in Bangladesh were both on declining trend in FY09 from Q2 onward, driven by decline in global prices of oil and other commodities, helped also by bumper domestic output of the boro rice crop. In H1 FY 10 the point-to-point inflation was on fluctuating trend with upward bias both in food and non-food inflation. Prices of food and non-food commodities have firmed up in international markets, with many of these on uptrend. Given the current trends of internal and external prices, both food and non-food point-to-point CPI inflation in Bangladesh looks set to continue over the coming months on a fluctuating trend with some upward bias; the 12-month average CPI inflation accordingly ceasing decline, and creeping upward in H2 FY10 but remaining within the 6.5 percent ceiling projected earlier in the MPS for H1 FY10. The 6.71 percent point-to-point and 5.11 percent 12-month average CPI inflation in Bangladesh as of October 09 are both moderate compared to double digit inflation levels in neighboring India and Pakistan.

Fiscal developments:
The Taka 301.5 billion revenue earnings during July-November 09 were 14.1 percent higher than earnings during same period of FY 09; apparently on course for attaining the Taka 794.61 billion FY 10 revenue growth, with high growth in income tax and other NBR tax receipts offsetting the low growth in custom duty receipts. Total government expenditure during July-November 09 is estimated at Taka 342.1 billion.
Budget deficit for July-November 09 stood at Taka 111.2 billion, the estimated deficit for full FY 10 will stand revised at Taka 313.58 billion (4.57 percent of GDP) against initial estimate of Taka 343.58 billion. Foreign financing of the deficit has been estimated at Taka 154.83 billion The recently declared government decision to revise interest rates on National Savings Scheme deposits in line with market rates, when implemented, may to some extent alter the estimated relative shares of bank and non-bank budget financing. Lower dependence on banks for domestic financing of budget can be expected to benefit the private sector by way of readier, more affordable access to bank credit.

External sector trends
Despite gradual growth slowdown from Q2 FY09 onward, exports of Bangladesh registered 10.3 percent growth in FY09 while those of regional neighbors were on decline. The slowdown continued in FY 10, bottoming out at 11.7 percent y-o-y decline in Q1 FY 10, commencing slow recovery thereafter with a lower (6.9 percent) y-o-y decline for July- November 09. Recent increasing trends of opening input import LCs by manufacturer-exporters indicate that exports will soon be back on growth path, hopefully matching in FY10 the FY09 feat of double digit growth Following 4.1 percent growth in FY 09, imports declined by 12.5 percent y-o-y during July-November 09. Trade deficit narrowed, the decline in import payments being higher than the decline in export receipts in absolute terms. The narrower trade deficit and continuing strong growth in workers’ remittances (22.9 percent y-o-y during July-December 09, the inflows presumably including transfers of savings besides transfers from current income for family subsistence) swelled the bop current account surplus (USD 1692 million surplus during July- November 09, against USD 79 million deficit during the same period of FY 09). Foreign exchange reserves increased correspondingly, crossing a new milestone of USD 10 billion in November 09, aided further by USD 740 million budget support for GOB from ADB and by positive net foreign investment inflow.

Developments in money and credit:
High growth in foreign assets at the expense of growth in domestic assets characterizes monetary developments in H1 FY10; for reasons already discussed in the foregoing sections. Slow off-take of bank credit from deposits and soaring workers’ remittance inflows led banks to leave large excess balances in their Taka and foreign currency accounts with the BB, causing surge in reserve money growth. Inter bank call money rates plunged to near zero levels in Q1 FY10. To engage with the market towards limiting the liquidity growth, BB resumed auction of 30 and 90 day BB bills, and from October 09 resumed reverse repo auctions after lowering the repo and reverse repo rates by 200 basis points respectively to 4.5 and 2.5 percent, levels closer to the then current call money rates. Economic activities including LC opening for capital machinery imports are picking up steam from Q2 FY 10, with gradual increase in private sector led growth of domestic credit (charts 2.5-2.8, table 2). Growth of foreign assets of the banking system will.

Bangladesh Bank
Monetary Policy Statement, January-June 2009

Outcome and outlook:

6.2 percent real GDP growth in FY 08 under challenging circumstances, momentum in growth of domestic output continued largely unimpaired in H1 FY09, in benign conditions of climate for agricultural output and of downturn in global prices of fuel oil and other major import commodities. The global financial turmoil originating from collapse of price bubbles in assets and commodities has not impacted Bangladesh significantly because of our limited exposure to short term external capital flows; but the continuing slowdown in global output growth poses some uncertainty about near term prospects for export growth, workers’ remittance receipts, ODI, FDI and FPI.

Satisfactory domestic agricultural output and the collapse of global commodity price bubble afforded respite in Q2 FY 09 from the unrelenting uptrend of CPI inflation of the recent past. Annual average CPI inflation of 9.94 percent as of June 08 crept up further topeak at 10.06 percent as of September 08, declining to 9.8 percent and 9.37 percent in October and November 08 respectively. Decline in fuel oil import prices have partly been passed on to consumers, with the remainder easing the fiscal burden of price subsidies. The lower prices of other imports are also gradually passing through to local consumer prices, and annual average CPI inflation is expected to decline further, to around 8.5 percent by the end of FY09, against the initial projection of 9.0 percent in the MPS issued in July 08.

Monetary outcome and outlook, stance for H2 FY 09:
The revised outlook for FY09 GDP growth and CPI inflation mentioned above warrant no major change in the monetary policy stance announced in the July 08 issue of MPS seeking to ensure adequate monetary accommodation for 6.5 percent real GDP growth in a scenario of 9.0 percent CPI inflation. The pursued policy stance has yielded good results in respect of growth, inflation and shielding of the economy from the global financial turmoil; with the macroeconomic fundamentals and stability of the Bangladesh economy widely viewed as being amongst the best in the South Asian and other comparator countries. Unlike economies facing heavy capital outflows and credit crunch in the current global turmoil, credit and liquidity conditions remain easy in the Bangladesh economy, with no need for any blanket, economy-wide monetary or fiscal stimulus. However, problems and weaknesses if any arising in specific sectors will be addressed with appropriate monetary and fiscal support. BB will continue to maintain pressure on banks for enhancing management efficiency and slimming down of intermediation spreads, so as to permit lowering of interest rates on loans for productive and supply augmenting activities while also maintaining real positive interest rates on bank savings

Policy tools and approaches
Monetary policies pursued by BB seek to accommodate adequate credit growth for attaining the projected real GDP growth and to contain CPI inflation within the targeted ceiling, with smooth adjustment to the transient internal or external shocks facing the economy. Annual monetary programs consistent with the projected real GDP growth and CPI inflation are formulated every financial year, with broad money (M2) and reserve money (RM) respectively as the intermediate and operating targets. BB routinely uses the repo and reverse repo interest rates and operations in regulating the levels of reserve money, to influence the growth of broad money and its components on the asset (credit) and  liability (currency and deposit) side, these in turn impacting the activity levels and price levels in the real economy. Changes in Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for scheduled banks are the other monetary policy tools that are used less often, in situations of drastic imbalance resulting from major shocks.

The global financial turmoil and its impact on Bangladesh economy
The sustained Bull Run in global commodity prices fuelled to a large extent by speculative transactions swung rather abruptly into downturn from mid 2008, triggered by the market wide freeze-ups of lending activities in major financial institutions deeply distressed in the earlier collapse of house price bubbles in major economies, laying bare their shocking dereliction in risk management in heavy exposures to opaque derivatives based on sub-prime mortgages and on loans to excessively leveraged corporate. The credit crunch and freeze-up in the major financial markets are being addressed with massive bailouts and stimulus packages to overcome the resultant economic slowdown; but it may take all of the year 2009 and perhaps even longer for the global economy to be restored back on trend growth path.

Because of the limited openness and exposure to short term external capital flows, the Bangladesh economy has thus far remained well shielded from the financial turmoil and credit crunch in the global financial market. Liquidity and credit conditions in the domestic financial market remain easy and comfortable; Taka USD exchange rate, foreign exchange reserve levels and market interest rates on Taka loans have remained stable, without any undue volatility. The downturn in global commodity prices is also easing domestic consumer price pressures and fiscal burdens of input and output price subsidies for producers and consumers.

Fiscal developments:
Upfront draw downs of expenditures on new social safety nets, subsidies and elections, insufficiently covered by slower than expected growth in tax receipts caused the government’s bank borrowings in H1 FY 09 to exceed the projections in BB’s monetary program, increasing by Tk 75.34 billion during July-15th December 08 against BB projection of Tk 43.0 billion for the entire H1 FY 09. The increase was however well within the budgetary projection of
Tk 136.0 billion for full FY 09.

Tax revenue receipts grew by 17.0 percent during July-October 08 against budgetary projection of 18.3 percent annual growth rate. Import duty receipts increased by only 11.9 percent over July- October 08 against a high 31.7 percent increase in import LC settlements though there was no major change in duty rates. The reasons behind the low growth in import duty receipts inspite of high increase in import LC settlements may be worth looking into.

Although FY 09 import duty receipts are likely to be lower than the initial estimates because of the decline in prices of import commodities, price subsidy expenditures will also be lower for the same reason; and the overall fiscal deficit financing is expected to remain well within the budgetary estimate of 5.0 percent of GDP

10 January 2008
The prime objective of the policy stance for H2 FY08 is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal, and monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of FY08.

The monetary policy stance for Bangladesh for the first half (H1) of FY08 was announced through the MPS in July 2007. Keeping in view the BB’s overall objective of supporting the highest sustainable output growth along with maintaining price stability, the MPS for H1 FY08 reiterated its intention to follow a monetary policy primarily to arrest the uptrend in inflationary tendency and reduce inflation expectations. The monetary policy stance for H1 FY08 was designed around a projected real GDP growth rate of 7.0 percent and an annual average CPI inflation within a range of 6.5 percent to 7.0 percent during FY08. The MPS mentioned that BB would regularly review its policy rates and SLR/CRR of banks in order to ensure consistency with unfolding price developments. The major emphasis of the policy stance was on providing necessary support towards achieving the desired rate of economic growth Over the last six months, the policy stance announced in July 2007 was moderated in the wake of several unexpected domestic shocks and unfavorable international developments that brought about significant changes in the macroeconomic scenario.

In the backdrop of the above developments, the monetary policy stance for H1 FY08 faced the following key challenges:
• Strong inflationary pressure emanating from both domestic and external sources that led the CPI inflation to overshoot the targeted range of 6.5 percent to 7.0 percent for FY08;
• Low level of investment and overall economic activity resulting from natural disasters and shaken business confidence;
• Lagged effects of higher than programmed monetary expansion during FY07 and earlier years;
• Excess liquidity and relatively high spread between deposit and lending rates in the banking sector;
• Emergence of current account deficit resulting from widened trade deficit despite a healthy growth in workers’ remittances;
• Disruption in normal economic activity, especially in the agriculture sector and the rural economy, due to two consecutive floods and a devastating cyclone and the urgent need to undertake relief and rehabilitation efforts;

Inflationary Trends and FY08 Outlook
The FY07 ended with a CPI inflation rate of 7.2 percent in June 2007 that exceeded the FY07 target of 7.0 percent. The strong inflationary pressure inherited from FY07 along with adverse changes in prospects for domestic production (mainly due to floods and cyclone) and the persistently rising prices in the international commodity market led to a steady rise in the inflation rate since the beginning of FY08.

The rise in the inflation rate in H1 FY08 can be attributed more to supply constraints caused by both external and internal shocks, while the demand factors remained mostly subdued as evidenced from the existence of huge excess liquidity in the banking system. This has been mainly due to deceleration in economic activities following natural calamities, reform measures, and administrative drives against corruption and tax evasion. Moreover, Bangladesh being an import-dependent country, the economy remains highly susceptive to price changes in international commodity markets especially that of food items.

External Sector Developments
The trade deficit widened to USD 1,739 million during the first four months of FY08 as a result of robust import growth (by 19.5 percent on adjusted fob basis) and negative export growth (by 3.1 percent on adjusted fob basis). As a result, despite a healthy growth in workers’ remittances (by 28.7 percent over the same period), the current account balance showed a deficit (USD 229 million) in July-October 2007 as against a strong surplus (USD 334 million) in the same period of 2006. However, with the causal factors underlying the decline in RMG exports taken care of, there are signs that export growth would soon bounce back to its trend level and Bangladesh would be able to maintain reasonable external sector stability during FY08 through materializing its good export prospects, ensuring the present healthy growth in the inflow of workers’ remittances, and maintaining a strong foreign exchange reserve position.

Since the beginning of FY08, the foreign exchange market has remained orderly although Taka exhibited marginal appreciation against USD as of end December 2007 indicating healthy situation in the balance of payments, build up of foreign exchange reserves, and appropriate policy stance of the Bangladesh Bank, such as intervention by sale of USD in the inter bank market.
Given the present comfortable foreign exchange reserve position, the appreciation of Taka would contribute towards easing the inflationary pressure at least in part by discouraging the pass through of international prices on domestic inflation.

Fiscal Sector Developments
In the FY08 budget, total current expenditure is set at Tk. 529.0 billion while total development expenditure is Tk. 285.2 billion. The overall budget deficit is projected at Tk. 223.1 billion (4.2 percent of GDP excluding grants and BPC), to be funded by Tk. 42.6 billion in foreign grants, Tk. 63.1 billion in net foreign borrowing, and Tk.192.8 billion in domestic borrowing including bank borrowing of Tk. 72.5 billion. The BPC’s accumulated loss of Tk. 75.2 billion is included in the budget although this would not create any immediate additional fiscal liabilities as it would be financed by issuing ‘Non-Cash Bonds’.
This new arrangement segregated the BB’s role in government debt management from its monetary policy operations although there does not exist any in-built mechanism to limit government bank borrowing within the ceiling of budgetary provisions. Following the changed treasury rules, the BB holds Treasury bills and bonds at cut off rate if market supply of fund falls short of government’s demand set by CDMC (known as devolvement). The flow of foreign fund also notably increased over the same period in the previous fiscal year. As such, the government (net) borrowing from the banking system has been much lower than the program limit although the government is currently facing the challenge of funding the massive rehabilitation and reconstruction program after the floods and the cyclone.

Recent Monetary Developments
Bangladesh Bank has been following a monetary policy stance since H2 FY05 aimed at containing demand side pressures that contribute to inflationary build up in the economy.
Despite significant pressure from rising prices in the international market and production shortfalls of major commodities in the domestic economy, an upward revision of the policy interest rates and reintroduction of BB bills in FY07 helped in limiting inflation at 7.2 percent, which is not far off the targeted rate of 7.0 percent for the year. However, the growth in M2 at the end of June 2007 exceeded the target (actual of 17.0 percent as against the target of 14.7 percent) and the growth rate of private sector credit was 15.1 percent compared with the programmed rate of 13.9 percent and the previous year’s growth rate of 18.3 percent.

During H1 FY08, BB introduced the required flexibility in implementation of its policies to meet the short term exigencies especially after the floods and the cyclone, such as ensuring the flow of adequate credit to productive sector like agriculture, SMEs, low cost housing, and other priority sectors and to women entrepreneurs. The BB’s refinance scheme for housing loans for lower and middle income groups was also put in place.

With the observance of financial discipline and introduction of significant reforms in the monetary arena, M2 recorded a growth of 14.2 percent (y-o-y) at end October 2007. The growth of private sector credit stood at 16.3 percent at the end of October 2007. BB has taken steps to ensure close supervision on the performance of three state owned commercial banks (SCBs),  Sonali, Janata and Agrani Banks, which have recently been transformed into public limited  companies. This will help to improve their efficiency.

The monetary policy stance followed in FY08 was announced in two statements: MPS for H1 FY08 was announced in July 2007 and the MPS for H2 FY08 in January 2008. The policy stance for H1 FY08 was designed around a projected real GDP growth of 7.0 percent and an annual average CPI inflation within a range of 6.5 percent to 7.0 percent. The developments during H1, however, led BB to revise GDP growth rate downward between 6.0 percent and 6.2 percent and average CPI inflation upward between 8.0 percent and 8.2 percent for the MPS for H2 FY08. The policy stance of H1 FY08 was moderated due to several unexpected domestic shocks and unprecedented global price developments bringing significant changes in the country’s macroeconomic scenario. Two consecutive floods and a devastating cyclone (Sidr) seriously interrupted overall economic activities, especially in the rural areas, which were further dampened by shaken business confidence. In addition to domestic production and supply disruptions, persistent rise in international prices of rice, wheat, edible oil, petroleum, and other essential commodities exerted significant pressure on domestic prices and led the inflation to move above its projected range. Despite a healthy growth in worker’s remittances, curren t account balance was strained due to widening trade deficit. Real sector growth slowed down along with the urgent need to undertake relief and rehabilitation activities for the disaster affected people and bring back production activities, especially in the agriculture sector, on track.

In view of these developments, the monetary policy stance of H2 FY08 aimed, in addition to containing inflation within tolerable limits, at supporting the government’s growth stimulating and poverty reduction programs through using the monetary instruments at the disposal of BB.
The imperatives identified for H2 FY08 covered two strategic thrusts: first, ensure reasonable price stability and support the building up of the economy’s adjustment capacity to internal and external shocks; and second, put in place more effective monetary and financial measures to accommodate growth augmenting policies. In this context, the policy stance gave priority to ensuring the flow of adequate credit to productive sectors, especially agriculture, SMEs, infrastructure, and other rural activities, and to women entrepreneurs. The policy stance also put emphasis on pursuing policies that would not unduly depreciate Taka that could generate inflationary pressures from rising import prices of such essential items as food and oil. Such impact could be strong especially in the short run because of rising and inelastic demand of these commodities in the domestic market.

Domestic Developments: Macroeconomic Outcome and Outlook
Economic Growth
The real GDP growth rate for FY08 is estimated at 6.2 percent (as projected by BB), which is slightly lower than 6.4 percent achieved in FY07. In FY08, agriculture grew at 3.6 percent, while the growth rates of industry and services sectors were 6.9 percent and 6.7 percent respectively. Although natural disasters like consecutive floods and cyclone and adverse developments like shaken business confidence affected the performance of the real sector during H1 FY08, the  economy rebounded in H2 along with a sharp recovery in RMG exports and record production of  boro rice, potato, wheat, maize, and other crops. The production in the agriculture secto bounced back due to measures taken by the government to ensure timely supply of adequate inputs, steps taken by BB for speedy disbursement of higher amount of agricultural credit, favorable incentives of the farmers to increase production resulting from higher prices of food grains, provision of cash subsidy to the farmers to compensate for higher diesel price, and other efforts to encourage the farmers to go for higher production. The industry sector, which was affected by sluggish investment and low performance of export-oriented manufacturing in H1 FY08 rebounded strongly in H2 with rebound in exports of RMGs, increased private sector credit, and increased imports of industrial raw materials. While a good part of the services sector activities such as trade and transportation remains structured around agriculture and industry sectors of the economy, the new and more dynamic fast-growing components including telecommunication (especially mobile phone), computer and internet, education, health care, and financial intermediation maintained healthy growth in FY08.

Inflation Outlook
The 12-month average CPI inflation was 7.20 percent in FY07 and rose to a high of 10.00 percent in March 2008 and then declined to 9.94 percent in April 2008 and further to 9.87 percent in May 2008. The persistent rise in inflation during most of the period of FY08 was contributed by both internal shocks (disruptions in production and supply due to repeated floods, cyclone, and other events) and external developments (unprecedented rise in world commodity prices notably of food items and fuel oil). The rise in domestic inflation was fed by food inflation which went up to 11.93 percent in May 2008 from 8.11 percent in June 2007, while non-food inflation rose to 6.72 percent from 5.90 percent over the same period.  21. Contrary to the rising trend of inflation as a global phenomenon, inflation in Bangladesh has started to ease since Q4 FY08 due to the pursuit of prudent policies. Overall, the expectation is that CPI inflation would come down further in the coming months through the pursuit of more prudent policies under the present monetary policy stance. The inflation episode that Bangladesh experienced in FY08 emanated largely from higher prices of food items, in the backdrop of global increase in food prices. The situation raises issues relating to the nature and extent of import price pass-through to domestic price since it is likely that goods with higher domestic supply components face a lower pass-through elasticity of import prices.
Along with gearing up of economic activities, optimal combination of several measures would be important to restrain inflation, such as rationalization/reduction of duties, appropriate phasing and timing of import of food grains and essential food items, strengthening internal procurement of food grains, increasing the efficiency of food grain trading and marketing, installing effective market monitoring and surveillance system, efficient programming of targeted distribution and open market sale operations, and other measures to reduce any undue strain on market operations. While BB policy stance would be to lessen the pressure on inflation through increasing supply of outputs and keeping demand pressure within control, the target rate of average inflation has been taken at around 9.0 percent for FY09.

External Sector Developments
Although export growth remained subdued in the early months of FY08, export earnings showed credible performance afterwards marking a growth of 15.3 percent during July-May FY08. However, a robust growth in import over July-April by 24.9 percent resulted in a widening trade deficit of USD 4,656 million during July-April FY08. Despite the surge in trade deficit, higher external aid flow and healthy growth in workers’ remittances (provisionally estimated at 32.8 percent in FY08) provided a cushion to the external balance, resulting in a surplus of USD 185 million in current account balance during July-April 2008. Overall, the balance of payments showed a surplus of US$ 140 million during July-April 2008 and may slightly moderate by the end of FY08 given prevailing high international prices and downturn in the global economy.

The foreign exchange market remained mostly stable in FY08 although the high inflow of remittance coupled with rising exports enabled Taka to appreciate slightly against USD. The BB, as a part of its pro-active monetary policy, remained active in the foreign exchange market and made necessary interventions through a net sale of USD 533 million up to June 2008 in the interbank market to help dampen inflationary pressure partly by cutting import costs of food items. The policy stance also enabled BB to maintain a comfortable foreign exchange reserve throughout FY08.

Fiscal Sector Developments
The overall fiscal deficit (excluding grants and BPC) for FY08 increased to Tk. 255.5 billion or nearly 4.8 percent of GDP compared with the original estimate of Tk.223.1 billion or 4.2 percent of GDP. The deficit was financed by Tk.130.2 billion from foreign sources and Tk. 199.2 billion from domestic sources, of which nearly Tk. 104.0 billion came through bank borrowing. Despite the scaling down of ADP by Tk.40.0 billion, the pressure on fiscal balance increased because of large increase in flood and cyclone relief and rehabilitation expenditures and rise in subsidies following the increase in fuel, fertilizer, and food grain prices in the international market.
The FY09 budget projects an overall deficit excluding grants of Tk.305.8 billion or nearly
5.0 percent of GDP, to be funded by Tk.63.5 billion in foreign grants, Tk.72.4 billion in foreign loans, and nearly Tk.170.0 billion in domestic borrowing including bank borrowing of Tk.135.0 billion. The projected expenditure will increase mainly due to widening and deepening of social safety net programs, substantial increase in subsidies on account of fuel, food, and fertilizer, and interest payments on past debt, and implementing income generating activities for the poor and disadvantaged households. The new arrangement for government bank borrowing introduced in FY07 segregated BB’s role in government debt management from its monetary management although there is no inbuilt mechanism to limit bank borrowing by the government.

Recent Monetary Developments
The monetary policy during FY08 aimed at gearing up economic activities along with
maintaining reasonable price stability. The average inflation rate went up to 10.00 percent in March 2008; but has been declining since then and stood at 9.87 percent in May 2008. Among the monetary aggregates, the growth of M2 was recorded at 17.5 percent in May 2008 down from 18.3 percent in May 2007 but higher than FY08 target of 16.0 percent.

In order to gear up economic activities while maintaining inflation at tolerable limit, the
monetary policy gave added priority to unhindered flow of credit to productive sectors,
especially in the rural areas, along with measures to keep the demand side pressure under control. The policy also focused on pursuing an exchange rate stabilization policy through sale of USD to the authorized dealers to prevent any undue volatility in the exchange rate. The policy resulted in a significant increase by 17.5 percent in bank advances to the private sector in March 2008 over the level one year ago with remarkable increase in credit flows to agriculture, industry, and working capital financing with consequent positive impact on economic activities.

While the overall outcome of the monetary policy in FY08 is positive, it would be important in the near term to guard against undesirable diversion of credit into unproductive and speculative purposes rather than redressing supply shortages in the economy in view of the relatively high growth of private sector credit experienced in the last fiscal.

In order to curb inflation expectations, the spread between short term and long term rates of government securities has been reduced through adjustments in yields on short term bills and long term government bonds. In the foreign exchange market, BB undertook measures to arrest undue volatility in the exchange rate to reduce the impact of world inflation on the domestic price level; keeping due attention to impact on exports and inflow of remittances.


Macroeconomic development: outcome and outlook
During the last three years real GDP grew on an average at above 6.0 percent up to FY 06. The growth momentum though expected to continue in FY07, the revised estimate of GDP growth rate has been revised lower to 6.5 percent from the projected range of 6.5–6.8 percent largely reflecting setback in agriculture that faced supply failure of fertilizers, shortages of power for irrigation and inadequate rainfall
Growth in the industry sector continues to be robust in FY07 owing to steady growth in export-oriented manufacturing and increased domestic demand. Looking at the growth trend of quantum index of manufacturing industries, it is expected that the growth in the industry sector would be within 10.0-10.5 percent. The buoyancy of growth in industry is supporting corresponding growth in the service sector. The accelerated pace of growth in the transport and communications sector would likely offset the apparent slow down in the construction and real estate sector.

Overall GDP growth, according to forecast for FY08, is expected to regain its momentum mainly representing the conducive economic and political environment created by the present government. Growth in the agriculture sector in FY08 is thus likely to be higher than that in FY07 aided by the projected higher disbursement of agricultural loans and supportive measures cited above. The industry sector is expected to continue to show robust performance in FY08 mainly due to steady growth in export-oriented manufacturing and new capacity addition especially in the telecommunications and the energy sectors.

FY07 commenced with an average inflation rate of 7.16 percent but eased to 6.72 percent by the end of January, ’07 reflecting both seasonality and restrictive monetary policy that was pursued. In the international front, prices of fuel, metals, food grains and other essential commodities soared, while in the internal front, selective depreciation in the exchange rate, revision of fuel prices, production shortfall of food items and political unrest, some of which have already been subdued, put pressure on the prices. Inflation rate, on an average basis, went up to 7.06 percent in May ’07 (8.05 percent on point-to-point basis).
Inflationary pressure was mainly felt on the food component, which went up to 8.02 percent at the end of May ’07 from 7.56 percent at the end of January ’07 while non-food inflation rose slightly to 5.67 percent at the end of May ’07 from 5.53 percent at the end of January ’07. Apart from steps to monitor supply in domestic markets, the government has taken price stabilization measures to ease the pressure which include withdrawal of duties, importation of food grain by the government, strengthening of internal procurement, provision for subsidy on fertilizers and diesel and widening of the Social Safety Net Programme. Besides, banks are now providing credit facilities on softer terms to new importers, easing the LC margin for food items, extending time limit for customer facility and arranging higher agricultural credit.

External sector:
Exports and imports grew by 18.50 percent and 17.83 percent respectively, year on year basis in first ten months of FY07. Growth in worker’s remittances was also steady at 24.52 percent up to June ’07. Surplus in the current account balance emanating mostly from robust growth in exports and workers remittances inspite of higher growth in imports helped releasing pressure in foreign exchange market that prevailed in the last part of H1 FY07.
With the marked increase in supply of foreign currency the foreign exchange reserves continued to build up to reach an all time high of 5.1 billion US dollar
Some downside risks in the global perspective in FY08 remains the main concern affecting external sector outlook. Besides, it has been apprehended that export sector of Bangladesh may bear some pressure with the end of restrictions on Chinese apparels by the end of 2007. However, increased flow of remittances, probable higher FDI flow, reasonable export growth and normal import trend are expected to persist in FY08. Bangladesh Bank will continue to use its monetary policy tools, if necessary, to sterilize liquidity to emanate from expected higher foreign currency inflows.

Fiscal Sector:
The overall deficit in the revised budget of the government for FY07 remained the same as in the original estimate and amounted to Tk. 173.64 billion or 3.7 percent of GDP, funded by Tk. 73.33 billion in foreign loans and grants and Tk. 100.31 in domestic borrowings including bank borrowing of Tk. 65.31 billion As indicated in the budget this will not create immediate additional fiscal liabilities as it will be financed by a “Non-Cash Bond” issue.
From the beginning of FY07, a modified arrangement of Government’s bank borrowings was put in place under the supervision of a Cash and Debt Management Committee (CDMC) chaired by Secretary, Finance Division. The new arrangement included a widened Ways and Means Advance Limit (Tk. 10.00 billion instead of Tk. 0.65 billion) and auction of treasury bills and bonds according to volumes pre-announced in the borrowing calendar. Until now, following the changed treasury rules BB holds treasury bills and bonds at cut off rate if market supply of fund falls short of Government’s demand set by CDMC

Monetary Developments:
Bangladesh Bank has been continuing to pursue a cautious, restrained monetary stance since H2 FY05 with a view to curbing excess demand from inflationary expectations. An upward bias in policy interest rates (Table 3.1) and reintroduction of BB bills in October 2006 helped in limiting inflation around the targeted seven percent despite international price pressure. In spite of cautious monetary policy, M2 year-on-year growth (18.2 percent) at the end of May ’07 exceeded the end-June target (14.7 percent), growth rate of private sector credit that mirrors a part of the aggregate demand grew at 15.6 percent which was lower than previous year’s growth rate of 17.1 percent. Net foreign assets of banking sector has been continuing to grow at a rate leading to the build up of foreign exchange .BB has been continuing to follow the cautious monetary stance with a view to ensuring that the existing inflation is not further fuelled by increased aggregate demand. However, BB is committed to ensuring flow of credit in the productive sectors like agriculture, small scale industries, low cost housing etc., where market has failed to deliver. BB has already taken a decision to introduce a refinancing scheme for housing loans for lower and middle income groups.
After strengthening the regulatory framework, improving the bank supervision process, and completing procedure for selling Rupali Bank, BB is now focused on corporatizing and restructuring the nationalized commercial banks (NCBs). The process of corporatization of three NCBs – Sonali, Janata and Agrani – has started.


Objectives, targets and instruments:
As usual, monetary policy pursued by BB aims at supporting the highest sustainable output growth while maintaining price stability, adjusting smoothly to the internal and external shocks faced by the economy from time to time. Monetary policy is accordingly designed around a projected real GDP growth rate, a moderate level of CPI inflation attainable/sustainable without unduly depressing output. Reverse repo and repo interest rates and BB bill rates are the routinely employed policy instruments for influencing financial and real sector prices towards the targeted path for inflation. Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for banks are less frequently used instruments that directly influence available volumes of credit. Annual monetary programs based on the projected real GDP growth and targeted inflation rate employ Reserve Money (RM) and Broad Money (M2) as intermediate targets, while also tracking other asset and liability side sub-aggregates.

Growth outcome and outlook:
Projection for real GDP growth for FY07 has been revised down to 6.5 percent following setbacks in the agriculture sector that experienced a moderate growth mainly due to inadequate rainfall, distribution problems relating to fertilizer, and shortages of power for irrigation. Growth in the industry sector continues to be strong in FY07 reflecting steady growth in export-oriented manufacturing and increased domestic demand. Industry and service sectors are expected to continue the robust performance in FY08. Following some government measures, growth in agriculture is expected to be higher than the previous year. Overall, real GDP growth is projected to be 7.0 percent in FY08.

Inflation outcome and outlook:
Annual average inflation in Bangladesh went down to 6.72 percent (below the target range 6.85–6.95 percent for FY07) in January ’07 from 7.16 percent in June ’06. Thereafter, annual average inflation rate showed an uptrend owing to rises in prices of fuel, metal, food grain and other essentials in the international market coupled with supply problems in the domestic front and reached 7.06 percent in May ’07. The government has taken some immediate measures to cope with the situation and is expecting to succeed in limiting annual average inflation to hover around 7.0 percent in June ’07. Despite continued unfavorable price development in the international front, the corrective measures taken by the government to handle the supply side rigidities and by BB to manage the demand side, the pressure on consumer price is expected to go down in the coming months provided there is no sharp and continued rise in the oil price.

Policy stance for FY08:
The cautious, restrained monetary policy stance followed by BB in the last 18 months would be continued during the first half (H1) of FY08 along with the supply-side measures taken by the government. Despite cautious monetary policy pursued by BB, the actual growth of several monetary aggregates exceeded the programme levels. It may be necessary to review BB policy rates. BB may review SLR/CRR of banks including Islamic ones which have remained unchanged since 2005, in view of the unfolding price developments. As before, the private sector will receive necessary policy attention to ensure desired level of economic growth. Following a strong growth of 5.4 percent in 2006, global output growth is projected to be 4.9 percent in 2007 (WEO, April ’07, IMF); while developing world would grow by 7.0 percent. Economic growth in Bangladesh has also got its momentum like its neighboring countries. Bangladesh experienced a real GDP growth of 6.63 percent in FY 06. The growth projection for current fiscal year is 6.5 percent. The policy strategy recently initiated and the reform programs undertaken by the government would not only help the economy to grow by 7.0 percent in FY08 but also pave the way for Bangladesh to become a member of the “middle income group country” by the end of the next decade.

External sector:
Exports and imports grew by 18.50 percent and 17.83 percent respectively, year on year basis in first ten months of FY07. Growth in worker’s remittances was also steady at 24.52 percent up to June ’07. Surplus in the current account balance emanating mostly from robust growth in exports and workers remittances in spite of higher growth in imports helped releasing pressure in foreign exchange market that prevailed in the last part of H1 FY07. With the marked increase in supply of foreign currency the foreign exchange reserves continued to build up to reach an all time high of 5.1 billion US dollar. It has been apprehended that export sector of Bangladesh may bear some pressure with the end of restrictions on Chinese apparels by the end of 2007. However, increased flow of remittances, probable higher FDI flow, reasonable export growth and normal import trend are expected to persist in FY08. Bangladesh Bank will continue to use its monetary policy tools, if necessary, to sterilize liquidity to emanate from expected higher foreign currency inflows.

Fiscal Sector:
The overall deficit in the revised budget of the government for FY07 remained the same as in the original estimate and amounted to Tk. 173.64 billion or 3.7 percent of GDP, funded by Tk. 73.33 billion in foreign loans and grants and Tk. 100.31 in domestic borrowings including bank borrowing of Tk. 65.31 billion The new arrangement included a widened Ways and Means Advance Limit (Tk. 10.00 billion instead of Tk. 0.65 billion) and auction of treasury bills and bonds according to volumes pre-announced in the borrowing calendar. This new arrangement segregated BB’s role in government debt management from its monetary policy operations but there is no in-built mechanism to limit government bank borrowings within the ceiling of budgetary provisions.

Monetary Developments:
Bangladesh Bank has been continuing to pursue a cautious, restrained monetary stance since H2 FY05 with a view to curbing excess demand from inflationary expectations. An upward bias in policy interest rates (Table 3.1) and reintroduction of BB bills in October 2006 helped in limiting inflation around the targeted seven percent despite international price pressure. Net foreign assets of banking sector has been continuing to grow at a rate leading to the build up of foreign exchange reserves that reached $ 5.1 billion by the end of June ’07. it appears that the gap between short term rates (of T-Bills) and those of 5/10 years BGTB is significant. This may be done by changing short-term interest rates and developing secondary market of government securities leading to lowering of yield on long term bonds. However, in adjusting short term rates one has to be careful in view of the fact that due to present situation of excess liquidity with the banks, BB may be able to withdraw money growth through reverse repo offering relatively higher rate of interest. BB has been continuing to follow the cautious monetary stance with a view to ensuring that the existing inflation is not further fuelled by increased aggregate demand. However, BB is committed to ensuring flow of credit in the productive sectors like agriculture, small scale industries, low cost housing etc., where market has failed to deliver. BB has already taken a decision to introduce a refinancing scheme for housing loans for lower and middle income groups.

Monetary Stance for FY08:
Keeping in view the prevailing price situation and enhanced excess liquidity emanating from moderating private sector credit demand and increase in net foreign assets, BB’s monetary stance will continue to be cautious in FY08. Despite persuasion of a cautious policy, growth in both money supply (estimated) and reserve money has exceeded the program levels at the end of June 2007. In this backdrop, further review of policy interest rates may be necessary. Since the bond/bill market is not yet developed to reduce the inflationary expectation in the longer term, interest rate of the instruments of the shorter tenor may have to be revisited relative to that of longer term. SLR/CRR of banks including Islamic ones have remained unchanged since 2005. In view of the unfolding price developments BB may review these rates. Above all, coordination among monetary, fiscal and trade policies is required to help curb rising inflationary pressure and achieving 7.0 percent economic growth in FY08. As before, the private sector will receive necessary policy attention to ensure desired level of economic growth.


Monetary policy strategy:
The MPS starts with articulation of the monetary policy framework in terms of the goals, instruments, and the channels of transmission. Maintaining price stability while supporting the highest sustainable output growth is the stated objective of monetary policies pursued by the Bangladesh Bank.

Growth outlook:
In view of good post flood recovery of agricultural output , stable manufacturing growth supported by continuing strong export demand of knit garments, robust service sector growth, and steady growth of remittances offsetting the deficit in trade balance, FY06 real GDP growth is expected to come in at the 6.3 to 6.8 percent range. Overall growth for the agricultural sector is likely to be in the 3.8 to 4.3 percent range in FY06, the principal contribution coming from the crop sub-sector. Industrial output growth for FY06 is expected to lie in a range of 8.0 to 8.5 percent, which is a shade lower than the 8.6 percent growth of FY05, but well in excess of the average recorded over the past five years. The service sector in FY06 is expected to build on the previous year’s performance to attain growth in the range of 6.5 to 7.0 percent.

Inflation outlook:
Over and above the high international prices of crude oil and continuing upward trend in prices of many other commodities, interest rates are on a rising trend in the global economy with associated increase in the inflationary expectations in the source countries of most imports. In the domestic scene, there is likelihood of another round of upward revision in the administered energy tariffs. On the positive side, in view of the bumper aman harvest, the food component of CPI is unlikely to register much further increase in the coming months. On balance, with the tightened monetary policy stance now adopted, the 12- month average inflation , at 6.9 percent as of November 05, is unlikely to exceed 7.0 percent over the remaining months of FY06 up to June 2006.

Policy stance:
In view of the continuing inflationary pressure, Bangladesh Bank remains alert as to the necessity of further monetary measures, and shall also seek such coordinated fiscal stance as may be warranted by developments in the real and monetary sectors; with a view to containing inflationary expectations and facilitating smooth credit flow for productive pursuits in support of the targeted real output growth. The Monetary Policy Statement (MPS) is intended to outline the objective and the modalities of formulation and conducting of monetary policy by the Bangladesh Bank, its asses sent of the recent and the expected monetary and price developments, and the stance of monetary policies that will be pursued over the near term . Objectives of the monetary policies of the Bangladesh Bank as outlined in the Bangladesh Bank Order, 1972 comprise attaining and maintaining of price stability, high levels of production, employment and economic growth.
interest rate and exchange rate are both market driven, exchange rate is no longer in the role of nominal anchor for prices.

The policy target(s)
As already mentioned, monetary policies in Bangladesh have the objective of maintaining price stability underpinned by the highest sustainable output growth, and are therefore formulated around inflation and output growth rates as the basic policy targets. Levels and growth paths of relevant monetary aggregates such as reserve money, broad money and domestic credit are also projected and monitored as intermediate targets in conducting monetary policies.

Inflation target:
CPI inflation, expressed as the rate of change of Consumer Price Index, is used in Bangladesh for measuring price stability in conducting monetary policies. Use of CPI inflation (sometimes also termed ‘headline inflation’) for this purpose is intuitively appealing because of its straightforward nexus with actual inflation experience of individuals and households.
Usefulness of such exclusion exercise is diminishing however, particularly in respect of tradable, with increasing external openness of the economies; domestic consumer prices of tradable are being increasingly influenced by international prices, apart from local conditions. Nevertheless, Bangladesh Bank is taking up empirical exercises to explore whether a ‘core inflation’ more stable than the CPI inflation can be suitably defined and used for monetary policy purposes. The target level of CPI inflation is chosen taking into account the country’s past long run inflation performance, and the domestic and external factors driving the current trend of domestic inflation. Apart from a brief spell of relatively high instability of prices in the mid seventies, inflation in Bangladesh has always been contained at moderate levels. The mid-single digit inflation level targeted here is well within the growth supportive range in inflation-output trade off for developing economies.

Growth target:
GDP growth projections of the Medium Term Macroeconomic Framework (MTMF) in the government’s National Strategy for Accelerated Poverty Reduction (NSAPR), modified appropriately in the light of unfolding actual developments, are used as output growth targets for the purpose of monetary policies. The MTMF projected 6.5 percent and 6.8 percent real GDP growth for FY06 and FY07 respectively. In view of the good post flood recovery of agricultural output and the better than expected holding up of apparels export demand after MFA expiry, real GDP growth targets for the purpose of monetary policies have been taken as 6.8 percent and 7.0 percent respectively for FY06 and FY07. Unavailability of intra year GDP growth estimates is a constraint in appropriate ongoing revision of monetary and other macroeconomic policies in the context of unfolding economic realities. Strengthening the capabilities of BBS towards regular estimation and release of reliable quarterly GDP data has therefore assumed priority.

Conducting of monetary policies
As mentioned in the foregoing, the near term inflation objective of monetary policies will be to contain the annual average CPI inflation, on an upswing phase since 2001, at around the current level under 7.0 percent. Monetary policies will therefore be on tightened stance until inflation levels off and enters its downswing phase.

Instruments employed
Interest rate: In tightening the monetary policy stance, key policy rates (treasury bill/bond auction yields, repo and reverse repo interest rates of Bangladesh Bank) have been raised and maintained on uptrend for these in turn to raise the rates of other financial costs and returns, restraining demand growth in the real sector.

Revision of the statutory ratios for scheduled banks:
In advanced economies with well developed deep and liquid money and financial markets, the policy interest rate interventions alone suffice in tightening or easing monetary stance to the extent desired; other interest rates representing the various financial costs and returns in the market adjust promptly and flexibly in response to changes in the policy interest rates. In developing economies like Bangladesh where the transition to market based regime is relatively recent, financial deepening is generally low with consumption and investment activities still substantially self financed the markets are yet to gain sufficient depth and liquidity to respond with desired speed and flexibility to changes in policy interest rates. To compensate for this inadequate interest rate responsiveness of markets, policy interest rate interventions in Bangladesh are at times supplemented by changes in the Cash Reserve Requirement (CRR) and Statutory Liquidity Ratio (SLR) for scheduled banks, thus influencing the volumes as well as costs of funds available for credit growth. In October 2005, the CRR and SLR were revised upward from 4.5 percent and 16.0 percent respectively to 5.0 percent and 18.0 percent of time and demand liabilities of scheduled banks, with a view to slowing down overall domestic credit growth as well as the growth of credit to the private sector.

Monitoring framework for monetary policy implementation:

  1. Monetary program
  2. Intermediate targets
As already mentioned, attaining and maintaining the highest sustainable output growth towards rapid reduction of pervasive poverty is the overriding priority for monetary and other macroeconomic policies in Bangladesh. Monetary and fiscal policies have significant mutual impact, and are therefore formulated and conducted in a mutually consistent and coordinated way with reference to the Medium Term Macroeconomic Framework of the NSAPR in attaining the growth, price stability and poverty reduction objectives


Objective, targets and instruments:
Monetary policies pursued by the BB aim at maintaining price stability while supporting the highest sustainable growth of domestic output. The price stability target is a moderate CPI inflation level realistically attainable/maintainable without unduly depressing output.
Reverse repo, repo interest rates are the routinely employed policy instruments, Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for banks are also used sparingly as instruments. Annual monetary programs based on the targeted inflation and projected GDP growth rates employ Reserve Money (RM) and Broad Money (M2) as intermediate targets, while also tracking other credit and deposit aggregates.

Growth outcome and outlook:
Estimated at 6.7 percent, real GDP growth in FY06 has touched the higher end of the 6.3-6.8 percent projection reported in the January 06 MPS. The 4.5 percent growth in agriculture reflected good post-flood rebound, the 9.6 percent growth in industry and 6.1 percent growth in services were underpinned by robust domestic and export demand. The growth momentum is expected to sustain or strengthen further in FY07 in industry and services, while agriculture sector growth may ease down somewhat towards its trend level. Overall, FY07 real GDP growth is projected to be in the 6.5-6.8 percent range.

Inflation outcome and outlook:
Annual average CPI inflation in Bangladesh was on slow upward creep throughout FY06, staying slightly above seven percent from December 05 onward (7.14 percent in May 06). External trade is steadily drawing domestic consumer prices closer to global prices. Growing export of perishable consumer items such as vegetables and fish are pitching their domestic prices towards the higher export prices. Higher import prices of major production inputs have cumulated to a sustained upward pressure on domestic consumer prices, despite partial shielding of pass-through of higher oil prices. This pressure being likely to persist in the second half of 2006 (April 2006 issue of WEO, IMF does not project significant easing of global commodity prices before 2007), monetary policies in FY07 will continue to target the containment of annual average CPI inflation within 7.0 percent, with possibility of some downward revision for the first half of 2007 based on review of developments in the second half of 2006.

Policy stance:
The cautious, restrained monetary stance pursued in the preceding quarters with steadily rising policy interest rates has thus far impacted only modestly on excess demand from inflation expectations.  Persistent rise in consumer prices is causing public disquiet in Bangladesh and neighboring countries; and while this need be addressed also on the supply side including measures to curb market manipulation, it will clearly be important to continue for the time being the tightened bias of monetary policy towards demand containment. As before, credit needs of productive sectors not adequately served by the credit market will continue to receive specific policy attention to ensure adequate and smooth credit flow.

External sector:
Sharp import growth in FY05 caused the current account of balance of payments to swing into deficit of about half a billion US Dollars, after three previous years in surplus. Depreciation of floating exchange rate of Taka, coupled with tightened monetary policy brought about a prompt turnaround to current account surplus by July 05, slowing down import growth to sustainable level and stimulating strong growth in export and workers’ remittances from abroad. Improvement in overall balance was somewhat slower, because of overhang of some deferred liabilities for oil and other imports of FY05. By April 06 however, overall balance has also turned around to positive, putting the foreign exchange reserves back on growth path. The floating exchange rate of Taka and the appropriately cautious monetary policy stance should retain the balance of payments in FY07 on a viable path, with continuing improvement in foreign exchange reserves as cushion against unforeseen future shocks.

Fiscal deficit and financing:
Overall deficit in the government’s FY06 revised budget amounted to Taka 161.90 billion or 3.9 percent of GDP, funded by Taka 24.76 billion in foreign grants, Taka 55.74 billion in foreign borrowing, and Taka 81.40 billion in domestic borrowing including Taka 49.11 billion from the banking system. Actual outturn in bank borrowing is likely to be close to the budgeted level, save an exceptional Taka 10.0 billion in government bonds issued to Sonali Bank in partial adjustment of its overdue loans to state owned BPC relating to petroleum imports. The government’s FY07 budget projects an overall deficit of Taka 171.98 billion or 3.7 percent of GDP, to be funded by Taka 25.08 billion in foreign grants, Taka 58.56 billion in foreign loans and Taka 88.34 billion in domestic borrowing including Taka 54.34 billion from the banking system. The bank borrowing projected in the FY07 budget is within normal trends and should pose no major issue for monetary policy. The huge overdue debt of BPC to the nationalized commercial banks (accumulating at the rate of about one percent of GDP per annum), resulting from incomplete pass-through of petroleum import costs to consumers, is an important issue for banking system liquidity as well as for smooth conducting of monetary policy.

Policy stance in FY06 and outturn:
Monetary policies have been on a cautious, restraining stance from the second half of FY05, with a view to curbing excess demand from inflationary expectations. Early in FY06 (in October 05), CRR and SLR were raised from 4.5 and 16.0 percent respectively to 5.0 and 18.0 percent of time and demand liabilities of scheduled banks, towards slowing down the growth of domestic credit and its component sub-aggregates. Reverse repo, repo interest rates and treasury bill/bond yield rates have been maintained on sustained uptrend. The cautious monetary stance together with exchange rate flexibility has served well to protect external sector viability by bringing back import growth to sustainable level, stimulating export growth and turning around the eroding net foreign assets back to growth path. Excess demand from inflationary expectations remains yet to be fully eliminated however, as indicated by the 19.9 percent year on year deposit growth in May 06 significantly lagging the 21.6 percent growth in domestic credit, with the later far higher than the nominal GDP growth rate in FY06. Excess demand from inflationary expectations is evidenced further by broad money and domestic credit being on significantly higher growth paths than projected in the FY06 monetary program.

Developing countries

Developing countries may have problems establishing an effective operating monetary policy. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is often because the monetary authority in a developing country is not independent of government, so good monetary policies takes a backseat to the political desires of the government or are used to pursue other non-monetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarization. Such forms of monetary institutions thus essentially tie the hands of the government from interference and, it is hoped, that such policies will import the monetary policy of the anchor nation.
Tools of USA Monetary policy 
The Fed can’t control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering a short-term interest rate called the “federal funds” rate. Most often, it does this through open market operations in the market for bank reserves, known as the federal funds market.
Bank reserves
Banks and other depository institutions (for convenience, we’ll refer to all of these as “banks”) keep a certain amount of funds in reserve to meet unexpected outflows. Banks can keep these reserves as cash in their vaults or as deposits with the Fed. In fact, banks are required to hold a certain amount in reserves. But, typically, they hold even more than they’re required to in order to clear overnight checks, restock ATMs, and make other payments.

 Federal funds market
From day to day, the amount of reserves a bank wants to hold may change as its deposits and transactions change. When a bank needs additional reserves on a short-term basis, it can borrow them from other banks that happen to have more reserves than they need. These loans take place in a private financial market called the federal funds market.
The interest rate on the overnight borrowing of reserves is called the federal funds rate or simply the “funds rate.” It adjusts to balance the supply of and demand for reserves. For example, if the supply of reserves in the fed funds market is greater than the demand, then the funds rate falls, and if the supply of reserves is less than the demand, the funds rate rises.
 Open market operations
The major tool the Fed uses to affect the supply of reserves in the banking system is open market operations—that is, the Fed buys and sells government securities on the open market. These operations are conducted by the Federal Reserve Bank of New York.
Suppose the Fed wants the funds rate to fall. To do this, it buys government securities from a bank. The Fed then pays for the securities by increasing that bank’s reserves. As a result, the bank now has more reserves than it wants. So the bank can lend these unwanted reserves to another bank in the federal funds market. Thus, the Fed’s open market purchase increases the supply of reserves to the banking system, and the federal funds rate falls.
When the Fed wants the funds rate to rise, it does the reverse, that is, it sells government securities. The Fed receives payment in reserves from banks, which lowers the supply of reserves in the banking system, and the funds rate rises.
Discount rate
Banks also can borrow reserves directly from the Federal Reserve Banks at their “discount windows,” and the discount rate is the rate that financially sound banks must pay for this “primary credit.” The Boards of Directors of the Reserve Banks set these rates, subject to the review and determination of the Federal Reserve Board. (“Secondary credit” is offered at higher interest rates and on more restrictive terms to institutions that do not qualify for primary credit.) Since January 2003, the discount rate has been set 100 basis points above the funds rate target, though the difference between the two rates could vary in principle. Setting the discount rate higher than the funds rate is designed to keep banks from turning to this source before they have exhausted other less expensive alternatives. At the same time, the (relatively) easy availability of reserves at this rate effectively places a ceiling on the funds rate.
Foreign currency operations
Purchases and sales of foreign currency by the Fed are directed by the FOMC, acting in cooperation with the Treasury, which has overall responsibility for these operations. The Fed does not have targets, or desired levels, for the exchange rate. Instead, the Fed gets involved to counter disorderly movements in foreign exchange markets, such as speculative movements that may disrupt the efficient functioning of these markets or of financial markets in general. For example, during some periods of disorderly declines in the dollar, the Fed has purchased dollars (sold foreign currency) to absorb some of the selling pressure.
Intervention operations involving dollars, whether initiated by the Fed, the Treasury, or by a foreign authority, are not allowed to alter the supply of bank reserves or the funds rate. The process of keeping intervention from affecting reserves and the funds rate is called the “sterilization” of exchange market operations. As such, these operations are not used as a tool of monetary policy.

Currency board

A currency board used by Federal Reserve is a monetary arrangement that pegs the monetary base of one country to another, the anchor nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are three-fold:
  1. To import monetary credibility of the anchor nation;
  2. To maintain a fixed exchange rate with the anchor nation;
  3. To establish credibility with the exchange rate (the currency board arrangement is the hardest form of fixed exchange rates outside of dollarization).
A gold standard is a special case of a currency board where the value of the national currency is linked to the value of gold instead of a foreign currency. The currency board in question will no longer issue fiat money but instead will only issue a set number of units of local currency for each unit of foreign currency it has in its vault. The surplus on the balance of payments of that country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the (net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the hands of the central
Quantitative easing
The term quantitative easing describes a form of monetary policy used to increase money in an economy when the interbank interest rate (in the US, this is called the Federal Funds Rate, in other countries the overnight lending rate) is either at, or close to, zero. In practical terms, the central bank purchases financial assets (mostly short-term), including government paper and corporate bonds, from financial institutions (such as banks) using money it has created ex nihilo (out of nothing).
Normally, a central bank increases the money in the economy indirectly by lowering the discount rate or reserve requirements, but when it cannot lower them any further it can attempt to seed the financial system with new money through quantitative easing

Tools of china monetary policy

Monetary policy implementation – instruments and constraints
The primary instruments of monetary policy used by the PBC include open market operations, the rediscount rate and reserve requirements. These are complemented by instructive credit plans, credit policy and “window guidance”, indicating the important role still played by non-market approaches in the implementation of monetary policy. Thus, the PBC uses a mix of indirect market instruments and more direct methods to control the volume and composition of credit flows. More recently, the PBC has been using growth rates of both money and bank lending as explicit intermediate targets. The relationship of these aggregates to real activity has not necessarily stayed stable over time. Furthermore, with the growth rate of M2 consistently being a few percentage points higher than nominal GDP growth over the last few years, there has been a trend decline in velocity, complicating things further. Yet, given their easy obserbility, targets for growth of these two aggregates have become an important device for the PBC to signal its monetary policy intentions and its assessments of growth and inflation prospects.
Financial institutions were also given the freedom to determine lending rates for individual borrowers based on their risk profiles and other characteristics
Reserve requirements have recently been used quite extensively as a monetary policy instrument.  In addition to changes in reserve requirements, differentiated reserve requirements were introduced in April 2004. This affected second-tier banks, including the joint stock commercial banks that had accounted for a significant part of the surge in lending growth in 2003.  Rural and urban credit cooperatives were exempt from this higher reserve requirement.

Notwithstanding the apparently wide range of instruments available to the PBC, there are three major factors that have complicated the implementation of monetary policy in China.
These include the exchange rate regime, institutional weaknesses in the financial and corporate sectors, and the large stocks of excess reserves that banks maintain at the PBC.
We discuss these in turn.

To recapitulate, monetary developments under the policy stance conveyed by the BB MPS have been positive; better balance between demand and supply has been attained, productive activities and growth in the economy have been well supported and external sector viability has strengthened. The targeted seven percent ceiling for annual average CPI inflation has however been breached, albeit by small margin, because of lingering excess demand from inflationary expectations. These factors along with continuing uptrend of global prices of oil and other commodities posing additional risk of further worsening domestic inflation imply that tightened bias of monetary policy will need to continue in every year as appropriate policy response towards maintaining macroeconomic stability and containing inflation. Monetary developments are under constant monitoring and continuous review, and the policy stance will be appropriately adjusted promptly responding to any major unforeseen change in the unfolding domestic and external economic realities.