The Bangladesh Bank's recently announced monetary policy statement (MPS) for the second half of FY25 continues its contractionary stance, aimed at curbing inflation while cautiously supporting economic recovery. However, this policy shift has substantial implications for Bangladesh's capital market, influencing investor sentiment, stock valuations, and liquidity.

The central bank aims to curb inflation and stabilise the foreign exchange market while tackling non-performing loans (NPLs). This MPS adopts a pragmatic approach, setting realistic targets and prioritising stability amid global and domestic uncertainties.

The Bangladesh Bank has kept the policy rate unchanged at 10 percent. The Standing Lending Facility (SLF) and Standing Deposit Facility (SDF) rates are also unchanged at 11.5 percent and 8.5 percent, respectively. The inflation target remains within 7-8 percent.

The stock market reacts sensitively to monetary policy changes, particularly interest rate decisions. Higher interest rates make fixed-income instruments, such as government securities and corporate bonds, more appealing compared to stocks. This could reduce demand for equities, increasing market volatility.

Private sector credit growth is projected to remain at a modest 9.8 percent. This cautious approach to credit expansion may hinder the growth of businesses reliant on bank loans. If companies face liquidity constraints, investor confidence may decline, thereby impacting stock prices.

On the other hand, the bond market stands to benefit from current monetary conditions. Higher interest rates make bonds more attractive to risk-averse investors seeking stable returns. Increased bond issuance and trading activity could strengthen the fixed-income market as an alternative to equities.

The Bangladesh Bank's move toward a more flexible exchange rate under the crawling-peg system aims to enhance currency stability. A stable exchange rate reduces currency risks and enhances the attractiveness of Bangladeshi financial assets to foreign investors. The MPS anticipates that prudent exchange rate management will boost export growth and remittance inflows.

The central bank's tightening measures have constrained money supply growth, with broad money increasing by only 7.6 percent year-on-year as of December 2024, falling short of the projected 8.2 percent. The resulting liquidity crunch could dampen stock market activity as investors may hesitate to engage in riskier assets.

Before recent political transitions and economic reforms, daily stock market turnover averaged more than Tk 500 crore. However, in the last six months under the interim government, turnover has declined to a range of Tk 350-400 crore. This downturn highlights declining investor confidence and underscores the need for policy interventions.

While the Bangladesh Bank's contractionary stance aims at macroeconomic stabilisation, a more balanced approach could support capital market growth without jeopardising inflation control. A phased reduction in interest rates in the coming quarters could stimulate economic activity while keeping inflation within a manageable range. Strengthening the bond market through increased corporate bond issuance and enhanced investor education on fixed-income securities would provide viable investment alternatives and expand market participation.

Additionally, improving market liquidity by ensuring better access to financing mechanisms for businesses and investors can help stabilise trading volumes and sustain market confidence.

Furthermore, improving banking sector governance, as emphasised in the MPS, is essential. Key reforms to address asset quality reviews, NPLs, and governance issues could indirectly benefit capital market stability by ensuring a healthier financial ecosystem.

Lastly, the Bangladesh Bank's monetary policy for the second half of FY25 is a double-edged sword for the capital market. While necessary for inflation control and financial stability, its restrictive nature may slow stock market growth and corporate expansion. Developing alternative investment avenues, such as a stronger bond market and diversified financial instruments, could mitigate the adverse effects of a high-interest rate environment.

The author is a capital market analyst