Dhaka, Bangladesh (BBN) – A key policy unit urged the Bangladesh Bank (BB) on Tuesday to phase off lending rate cap and fend off inflationary pressure, saying excess liquidity in banking system could fuel prices and create asset bubble.

BB’s Policy Analysis Unit (PAU) sounded the inflation alarm in its latest monetary policy review although the point-to-point consumer price index (CPI) came down to 2.25 per cent and 12-month average to 6.6 per cent in June.

It said high liquidity in the banks — which grew a 165 per cent in a year to hit a record BDT 347 billion at the end of June — and price rise at the real estate sector and stock markets could stoke inflation rapidly.

“Unless utilized rapidly in fiscal year 2009-10 (FY10) in productive activities and investments the liquidity overhang may create inflationary pressure in consumer prices and in asset (stocks and real estates) prices,” the Unit said in its latest analysis.

The PAU’s review suggested resumption of the reserve repurchase agreement (repo) operations to mop up surplus liquidity and increase call money rate from the existing “very low levels”.

“If productive and supply augmenting economic activities prove slow to rebound and if the prevailing large liquidity overhang tend instead to be channeled to speculative activities stoking inflationary pressure; BB will need to resume reverse repo operations intensively to siphon off enough Taka liquidity to result in substantial rise in overnight inter-bank interest rates from the current very low levels,” it said.

The inter-bank call money market has hit the rock bottom in the past few weeks as most banks are sitting on piles of liquid cash.

On Tuesday most of the deals were concluded at rates between 0.10 per cent and 0.20 per cent.

Non-acceptance of reverse repo by the central bank since March 25 this year also contributed to the decline in call rate sharply, market operators have said.

The PAU said low outflows for imports and workers remittances and export proceeds resulted in the “liquidity overhang”, which brought down call money rates, deposit interest rates and yield rates on treasury bills and bonds.

It suggested a close watch on credit flows in key economic sectors including the real estate in the coming months for curbing price pressures on the economy.

The unit said the decline in consumer price index (CPI) inflation in FY10 is likely to be slow and relatively modest, and is projected to be 6.5 per cent in June 2010 against the current level of around 7.0 per cent.

The review said the lending rate cap the central bank was forced to introduce in April was “unhelpful” and suggested its phasing-off in the coming months.

“While justifiable as necessary immediate measure to address the uncompetitive behavior of banks in pricing of financial services, interest rate ceilings are unhelpful for development of secondary markets in debt,” the PAU said.

The BB had said it imposed the lending rate ceiling at 13 percent in an effort to boost investment in the country, curb liquidity surplus and fight off the weakening demand created by the global economic recession.

But the Unit in its review said the capping has led to some market distortions.

“The BB will need to address the issue of activating competitive market behavior in banks in a comprehensive manner, phasing off the mandatory interest rate prescriptions as competitive trends gain traction and show signs of taking hold,” it suggested.

BBN/SS/SI/AD-19August09-2:09 am (BST)