Monetary Policy and Capital Market Development in Bangladesh Policy Note: PN 0708
Shubhasish Barua* and Md. Habibour Rahman* Abstract
Bangladesh Bank (BB) adjusted its monetary policy stance during 2005 in order to contain inflationary pressures and facilitate stability in the foreign exchange market. At the end of 2005, interest rates on NSD certificates were also adjusted upward. The latter development, however, raised some concern among different economic agents regarding its possible impact on the country's capital market. In this paper we attempt to closely inspect the evolvement of monetary policy and capital market indicators in recent years and their possible interrelationship to ...view middle of the document...
We focus our analysis on the period, January '02 to December '06. Data on capital market indicators are collected from monthly reviews of Dhaka Stock Exchange (DSE), while interest rates and Treasury bills data are taken from various Bangladesh Bank's sources. In a modern monetary system central banks have control over very short term (overnight) or short term (covering several months) interest rates; long term (1-year or more) interest rates, however, are determined by inflation expectations and real activities.1 Relationship between monetary policy and stock prices can be understood within the stock price valuation model. When central bank raises the interest rates on monetary policy instruments, expected return on alternative assets (other than equity) rise, reducing the present discounted value of future cash flow or price of stocks. The rest of this paper is organized as follows. Section 2 provides a brief discussion on recent changes in monetary policy stance while Section 3 discusses the changes in yields and stock of Government T-bills and NSD certificates. Section 4 provides a review of recent development in the capital market. A parallel analysis is conducted in Section 5 and finally, Section 6 concludes the paper.
The authors are Research Economists of the Policy Analysis Unit at the Research Department of Bangladesh Bank and would like to thank Prof. Syed M. Ahsan, Resident Economic Adviser of Bangladesh Bank for his helpful suggestions and comments. The views expressed in this Note, however, are authors' own and do not necessarily reflect the views of the Bank. 1 The latter requires that there is a well developed secondary market for long term treasury bonds, which is still in its rudimentary stage in Bangladesh.
T-bill yield of all maturities rose sharply during FY03, but fell sharply at the start of FY04 and remained stable up to March '05, after that these started to rise steadily but gradually.7 Yields on 5 and 10-year BGTBs also show rapid rise since April '05. Following the rise in the yield of T-bills and bonds, growth of outstanding stock of these instruments reached its peak at the end of June '03. However, with the sharp fall in yields the growth of total outstanding stock started to decline rapidly from Sep '03 and fell to around 5.2 percent at the end of June '05. Despite the gradual recovery in the yields, growth of stock of government securities remained negative during FY06, and turned into positive figures only in the first half of FY07.8
Figure 2: Treasury Bills (up to 182 days): Yield and Growth of Stock
Source: Monetary Policy Department, Bangladesh Bank Quarterly
Treasury bills with maturity period of 28, 91 and 182 days also rose sharply during FY03, only to drop sharply by the first half of FY04 to their former level. Annual growth of outstanding stock was negative during September '02 to September '04. The weighted average yield on the 28-day and 91-Day T-bill started to increase...