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Monetary Policy and Capital Market Development in Bangladesh

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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 shed some light on the issue. Since prices of stocks are mainly determined by company fundamentals, monetary policy can have only short term effect on stock prices. Even in the short run, effect of interest rates on stock prices is less clear-cut, and in a less developed capital market like Bangladesh, stock prices do tend to respond, for short term, to new reform measures and government incentives.

1. Introduction 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 (government borrowing instruments from the non-bank public) 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. One recent study by Ahmed et. al. (2006) for Bangladesh found that contractionary monetary policy shock, measured by increases in short term policy interest rates have small, negative and short lived effect on the stock price index. In this paper we attempt to closely inspect the evolvement of monetary policy and…...

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