(Bloomberg) -- Bangladesh’s central bank introduced a crawling peg system for the local currency in efforts to keep the taka stable and raised its key interest rate to tame inflationary pressures.

The central bank introduced a crawling peg exchange rate system for spot purchases and sales of dollars and set the mid rate at 117 taka per dollar with immediate effect, Bangladesh Bank said in a statement Wednesday, without identifying any range. The currency declined as much as 2.2% to 111.96 taka per dollar on Thursday, according to local pricing compiled by Bloomberg.

“Scheduled banks may purchase and sell US dollars freely around the crawling peg mid rate with their customers and in interbank deals,” it said.

The step would serve as a transitional arrangement paving the way toward a fully flexible exchange-rate regime in the future and slow the erosion of its dollar reserves. The nation’s foreign exchange stockpile slipped to about $20 billion as of April, less than half their historic peak in 2021.

Bangladesh has made use of a series of fixed exchange rates to manage volatility since its independence in 1971. In June, Bangladesh pledged to allow the currency to float freely for the first time in the country’s history, a key demand from the International Monetary Fund to keep its $4.7 billion loan program on track.

The Bangladesh taka fell about 6% last year, one of the worst performers among emerging Asia, according to data compiled by Bloomberg.

Price Pressures 

The central bank also increased the overnight repurchase agreement rate for the second straight meeting by 50 basis points to 8.50%. The standing lending facility rate was raised to 10% from 9.50% earlier, while the standing deposit facility rate was hiked to 7% to “help banks better manage liquidity,” the central bank said. 

The policy decision comes as authorities are looking to curb price gains, which have inched up due to a rise in energy and food costs. Inflation has held above 9% since March last year and authorities have taken a raft of measures, including import controls to reduce price pressures. Inflation climbed 9.81% in March compared with 9.67% the previous month. 

Higher interest rates will slow demand and help reduce price gains, which Prime Minister Sheikh Hasina’s government aims to bring down to 6% in the year ending June. 

The International Monetary Fund welcomed the crawling peg, the lift to interest rates and other reforms to help restore external resilience. They were part of the staff-level agreement on the policies needed to complete the second review of a loan program for the country to receive $1.1b subject to approval by the lender’s board, according to a statement. 

“The macroeconomic outlook is expected to gradually stabilize as policy actions start to take hold,” Chris Papageorgiou, who led the IMF team during the staff visit between April 24 and May 8, said in the statement. “Nevertheless, uncertainties surrounding the outlook remain high, with risks predominantly leaning towards the downside.”

--With assistance from Malavika Kaur Makol, Matthew Burgess and Ronojoy Mazumdar.

(Updates with taka move against the dollar in second paragraph.)

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