Policy rate cut is a bet that cheaper money can revive an economy short of confidence

Bangladesh Bank’s first interest-rate cut in nearly two years is an attempt to prevent weak investment and industrial contraction from producing a prolonged economic slowdown.

The central bank on Thursday reduced its policy, or repo, rate by 50 basis points to 9.5%, effective August 2. It also lowered the Standing Lending Facility rate—the rate at which banks can borrow overnight from the central bank—to 11% from 11.5%, while leaving the Standing Deposit Facility rate unchanged at 7.5%.

The decision marks the beginning of a cautious easing cycle after Bangladesh Bank raised its policy rate from 8.5% to 10% between 2024 and 2025 to contain persistent price pressures. 

But the asymmetric adjustment to the interest-rate corridor suggests the central bank is seeking to relieve funding pressure on banks without yet encouraging them to park more money with the regulator.

The rationale is visible in the credit data. Private-sector credit expanded by only 4.98% year on year in May, down from 7.17% a year earlier and far below the rates normally associated with a rapidly industrialising economy. Public-sector credit, by contrast, grew 20.78%, indicating that government borrowing has become the principal driver of domestic credit creation.

Bangladesh Bank has already lowered its private-credit growth target to 6.8% for December, acknowledging that restrictive financial conditions, weak investor appetite, rising defaults and economic uncertainty have constrained both the demand for loans and banks’ willingness to provide them.

The rate cut is therefore intended to alter incentives. Lower central-bank funding costs should eventually reduce banks’ cost of money, pull down lending rates and make projects that were unviable at double-digit borrowing costs slightly more attractive. It may also help solvent borrowers refinance working-capital facilities and reduce the pressure on manufacturers facing weaker demand and higher energy expenses.

But the central problem is not simply the price of credit. It is the absence of sufficiently bankable demand.

The underlying problems 

Large-scale industrial production contracted 1.42% in the first 10 months of the 2025-26 fiscal year, compared with growth of 6.97% during the corresponding period a year earlier. 

Exports grew by only 0.17% over the full fiscal year, while import letters of credit increased modestly, suggesting neither a strong export-led recovery nor a broad surge in investment-related imports.

Factories also continue to face interruptions in gas and electricity supply. For an industrial company unable to run machinery reliably, a decline of half a percentage point in the policy rate does little to improve the expected return on a new production line. 

The cost of idle capacity, imported fuel, generators and missed delivery schedules can easily outweigh the savings from marginally cheaper bank finance.

This helps explain why some well-capitalised banks appear to have excess funds and are offering selected consumer loans at unusually competitive rates. Bangladesh’s banking system held 3.28 lakh crore taka excess liquid assets, including government securities, at the end of May. Cash above mandatory reserve requirements alone amounted to 16,373 crore taka.

Liquidity, however, is unevenly distributed. Strong private banks may have more deposits than credible borrowers, while troubled state-owned and Islamic banks face capital deficiencies and weak asset quality. A system can consequently possess substantial aggregate liquidity while individual institutions remain unable or unwilling to extend productive credit.

That fragmentation is the most serious impediment to monetary-policy transmission. Non-performing loans reached about 5.89 lakh crore taka at the end of March, equivalent to more than 32% of outstanding loans. 

The World Bank said the banking system’s capital-to-risk-weighted-assets ratio was negative 2.6% at the end of 2025, reflecting losses and severe capital shortages at weaker institutions.

A bank burdened by bad loans does not necessarily respond to a policy-rate cut by financing a new factory. It may instead preserve cash, purchase government securities or lend only to its safest existing customers. 

High Treasury yields have allowed banks to generate relatively secure income by financing the government rather than assuming the risks associated with businesses exposed to energy shortages, exchange-rate uncertainty and weak consumption.

The divergence between public and private credit growth illustrates this crowding-out effect. Government borrowing offers banks a comparatively safe return and requires less credit assessment than lending to companies. 

Unless fiscal borrowing moderates, part of the liquidity released through monetary easing may circulate between the central bank, commercial banks and the government without reaching private investment.

Ever-lasting inflation 

Inflation is the second constraint. Headline inflation eased to 9.16% in June from a 16-month high of 9.42% in May, but it remains far above the government’s 7.5% budget target. Wage growth was only 8.18% in June, meaning average real wages continued to decline.

The composition of inflation is also uncomfortable. Non-food prices contributed more to June inflation than food prices, with transport inflation and prices at restaurants and hotels remaining particularly elevated. This points to cost pressures that cannot easily be solved through interest rates, including energy, logistics and administered prices.

Monetary conditions are already becoming more expansionary. Broad money grew 12.45% in May, while reserve money increased 21.74% and currency held outside banks rose 18.92%. 

The increase in physical cash may partly reflect greater transactions demand, but it can also signal distrust in banks and weakens the deposit base from which credit would normally be created.

Cutting rates while reserve money is expanding and inflation remains above 9% is therefore a calculated risk. Flood-related food disruptions, energy-market volatility or further depreciation of the taka could reverse the modest improvement in inflation and force Bangladesh Bank to pause or even undo its easing.

The external position provides some room for manoeuvre. Remittances rose more than 30% to $35.59 billion in the past fiscal year, gross reserves reached $37.58 billion—or $32.93 billion under the IMF’s BPM6 calculation—and the overall balance of payments recorded a surplus of about $4 billion in the 11 months to May.

Yet the recovery remains vulnerable. S&P Global Ratings this week revised Bangladesh’s sovereign outlook to negative from stable while affirming its B+ long-term and B short-term ratings. 

The agency cited the weak banking sector, fiscal constraints, energy-market exposure, uncertain trade conditions and the possibility of a more protracted recovery. It estimated that non-performing loans at state-owned banks were about 40% and warned that poor capital adequacy would limit the sector’s ability to support economic growth.

Fitch had already moved its outlook to negative in May, pointing to external financing risks associated with instability in the Middle East, from where Bangladesh receives a significant share of its remittances and energy imports.

These assessments expose the dilemma behind Thursday’s decision. Maintaining a 10% policy rate would have done little to repair banks or restore gas supplies, while continuing to squeeze viable companies and consumers. 

Cutting too aggressively, however, could weaken the currency, revive inflation and reinforce the concerns that prompted the ratings agencies’ negative outlooks.

The most probable outcome is therefore modest rather than transformational. Lending rates should begin to ease, especially for top-rated corporate and retail borrowers. Companies with strong balance sheets may revive postponed working-capital borrowing, and targeted credit programmes could provide some support to agriculture, smaller businesses and selected industries.

But a broad investment revival will require more than cheaper money. It depends on reliable energy, resolution of distressed banks, stronger loan recovery, lower government reliance on bank financing, policy predictability and a political environment in which companies can estimate future costs and demand with reasonable confidence.

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