The fiscal trap beneath Bangladesh’s inflation

Inflation crises rarely begin with reckless money printing. They begin when an economy loses its capacity to generate productive growth while the state steadily absorbs more of the financial system.

At first the response is orthodox. Central banks raise interest rates, tighten liquidity, defend the currency and attempt to re-anchor inflation expectations. But if growth weakens, tax revenues stagnate, private credit collapses and government borrowing continues rising, tight monetary policy can itself become destabilising.

Higher rates raise the state’s interest burden faster than the economy’s capacity to support it. Eventually markets begin assuming future monetisation is inevitable, even if actual money printing has not yet accelerated. 

That is when inflation regimes become dangerous: savers flee domestic financial assets, the currency weakens structurally and monetary policy starts losing credibility.

Bangladesh is nowhere near hyperinflation. But parts of its macroeconomic structure are beginning to resemble the early stages of that kind of trap.

Consumer inflation has remained stuck around 9-10% despite one of the sharpest tightening cycles in Bangladesh Bank’s modern history. The policy rate now stands at 10%, the highest in years. 

The central bank has tightened liquidity, moved toward a more flexible exchange-rate regime and attempted to rebuild reserves after the external-sector stress of 2022-23.

Yet growth is slowing sharply. IMF estimates place GDP growth around 3.7-4% in FY2025, down from the 6-8% range Bangladesh sustained before the crisis. More worrying is private-sector credit growth, which has slowed to roughly 5.6-7.6%. 

With inflation near double digits, that implies negative real credit growth across much of the economy.

Corporate balance sheets have been weakened by energy shortages, import compression, high financing costs and weak demand. Meanwhile banks remain burdened by distressed assets, loan rescheduling and years of regulatory forbearance. 

IMF assessments suggest the true scale of non-performing loans may be far larger than official figures indicate.

In effect, Bangladesh’s private economy is deleveraging while the state increasingly dominates domestic borrowing. That changes how monetary tightening works.

A volatile trend

In textbook economics, high interest rates suppress inflation by reducing private borrowing. But when the government becomes the dominant borrower, high rates can become fiscally inflationary instead. The mechanism is straightforward:

Persistent deficits → rising sovereign borrowing → higher interest rates → rising public interest costs → faster debt accumulation → fears of future monetisation → currency weakness → inflation persistence.

Bangladesh is not yet in that category. Public debt remains around 40% of GDP, well below levels associated with classic emerging-market collapses. Fiscal deficits remain contained near 4-5% of GDP. 

Public-sector credit growth is rising, but not explosively. Foreign-exchange reserves, which fell sharply during the 2022-23 balance-of-payments shock, have partially recovered following exchange-rate adjustments, import compression and IMF support. 

There has been no failed sovereign auction, no sudden stop in domestic financing and no outright collapse in confidence in government debt.

But headline debt ratios obscure the deeper problem: Bangladesh’s fiscal capacity is extraordinarily weak.

Tax collection remains among the lowest in the world relative to GDP. Debt sustainability depends not only on debt-to-GDP ratios, but on debt relative to government revenues. Several analysts estimate public debt relative to annual tax revenue has risen sharply over the past decade, from roughly 3.4 times to over 5 times.

That matters because Bangladesh’s problem is not runaway fiscal deficits. It is a structurally weak tax state confronting slower growth, weak investment and rising financing costs simultaneously.

This has produced a growing divide inside policy circles.

Will orthodoxy in monetary policy help?

One side argues monetary orthodoxy must remain absolute. In weak institutional environments with shallow capital markets and fragile banks, exchange-rate stability becomes the economy’s nominal anchor. 

Bangladesh already experienced the consequences of deeply negative real interest rates after the pandemic: reserve losses accelerated, the taka depreciated sharply and dollarisation pressures intensified.

From this perspective, cutting rates to ease fiscal pressure would be dangerous. Lower rates would do little to revive lending because the banking system itself is impaired. Instead they could weaken confidence in the currency and revive expectations of future monetisation.

The opposing view focuses less on inflation today and more on debt dynamics tomorrow. If private-sector credit remains structurally weak because of banking distress, excess industrial capacity and weak demand, then high rates may simply compound fiscal pressure without restoring growth. 

The government becomes the primary borrower by default. Interest expenditure rises quarter after quarter while tax revenues fail to catch up. Under those conditions, the danger is not current money printing. It is the expectation of future money printing.

That is the crucial point often misunderstood in inflation crises. Hyperinflation does not begin when central banks first print money aggressively. It begins when markets conclude they eventually will have to.

Bangladesh is not facing a sovereign financing crisis yet. Inflation, though persistent, is not accelerating uncontrollably. The central bank still retains credibility if it maintains exchange-rate discipline and avoids politically driven monetary easing.

But beneath the surface, the economy is becoming structurally fragile. Real growth is slowing. Private credit growth is negative in real terms. Large parts of the banking system remain impaired. Tax revenues are structurally inadequate. Productive private investment is weakening while government borrowing continues rising.

That does not mean hyperinflation is imminent. The risk is subtler: a fiscal-monetary loop in which weak growth, high rates and rising sovereign financing costs begin reinforcing one another. 

Once markets begin believing future debt monetisation is inevitable, currency confidence can deteriorate long before actual money printing begins.