Originally posted in The Business Standard on 13 July 2024
Will another round of policy tightening ease inflation or squeeze the economy?
From June 2023, the Bangladesh Bank initiated a change in its monetary policy approach—from money-supply based to interest-rate based targeting– to better manage the ongoing inflation. It decided to follow the model that helped India tame its inflation.
Last year the central bank withdrew the interest rate cap of 6%-9%, blamed for keeping money cheap and fueling inflation. In its place, a market-driven reference rate formula was introduced. Interest rates have gone up faster than initially expected. Today a borrower is paying 16% on a consumer loan which was 9% last June— Tk7 more for every one hundred in more practical terms.
But the approach has not achieved the main goal – checking inflation. It remained well above 9% this June, same as in June last year. Despite slight decline month-on-month, annualised average consumer price index hit a 13-year high of 9.73% in the just-out fiscal year 2023-24 (FY24)—far from the revised target of 7.5%.
Monetary policy alone does not work where market mismanagement is rampant. To control inflation, authorities need to coordinate fiscal policy with monetary policy.
Flawed market system thwarts monetary policy
Economists now say the monetary policy, even though contractionary, is less likely to work in taming inflation as the approach was taken too late. Steps in the monetary policy were put into force only last July, but those did not have an immediate impact on inflation, says Fahmida Khatun, executive director at the Centre for Policy Dialogue.
She points to market flaws that limit impacts of monetary policy on inflation.
“Monetary policy alone does not work where market mismanagement is rampant,” Fahmida says, citing how a price-fixing market cartel artificially inflates prices of those items too which are locally produced and in abundant supply.
To control inflation, authorities need to coordinate fiscal policy with monetary policy, she suggests. Fahmida also believes a contractionary monetary policy cannot control inflation when the government remains in spending mode. “The administrative expenses of the government were very high. In such a situation, inflation cannot be controlled by tightening monetary policy alone,” she adds.
Hiked exchange rate and interest rate worsened inflation
Economist Zaid Bakht, former research director at the Bangladesh Institute of Development Studies, says inflation could not be controlled for two reasons—increase in exchange rate and increase in interest rates.
The two monetary policies that covered the full FY24, caused two changes — the first one led to significant hike in interest rate, the second one took the official dollar rate straight Tk7 higher– from Tk110 to Tk117.
Although the fiat interest rate has been withdrawn, the money supply is still not under control, Zaid Bakht says, explaining why inflation is not coming down.
Rather, higher interest and exchange rates made imports costlier, further contributing to inflation and slowing industrial output as evidenced in the second quarter data showing a drastic fall in GDP growth to 3.78% from 6.01% in the first quarter of FY24.
“A precipitous decline in the manufacturing sub-sector marked contraction in the sector’s growth in Q2FY24. The contraction in both domestic and external consumption because of high inflation, import restrictions amid the US dollar crisis, and the recent gas and electricity shortages have significantly impeded growth in the manufacturing sector,” the central bank’s review of its monetary policy says.
The momentum in the manufacturing sector slowed down during July–December of FY24, registering a growth rate of 3.86%. Nonetheless, amid a tight monetary policy stance, BB’s precedence to ascertain adequate credit flow to the economy’s productive sectors was further rolled up in the monetary policy statement (MPS) of July–December (H1) of FY24.
However, the third quarter data released last week by the BBS shows the economic growth recovered to 6.12% on strong performance in all three broad sectors—agriculture, industry and service.
Industrial output growth crossed 7% in Q3 of FY24, higher than in the same quarter of the previous fiscal year.
This indicates a rebound in the industrial sector, although export data corrected by the central bank earlier this month showed export proceeds in July-May period of FY24 was short by nearly $10 billion than the amount claimed by Export Promotion Bureau (EPB).
Shocking data calculation error
The shocking revelation put all economic assessments in question. Economists said the export data error calls for recalculation of all economic numbers to help policymakers revise major projections— from export to public debt to GDP growth. Bangladesh Bank recalculated its balance of payment numbers.
How will the Q4 economic data look if BBS takes into account the massive export data error?
The central bank governor at a meeting with economists and bankers last week said they would release real data of exports and bad loans.
He also hinted that the next monetary policy statement, expected next week, will be contractionary as well and it will be aligned with fiscal policy to bring inflation down below 7% in the new fiscal year (FY25).
“Maintaining a tight monetary policy stance throughout the latter half of FY24 seems prudent to manage inflation and stabilise inflation expectations while ensuring sufficient funding to support growth in the productive sectors of the economy,” the central bank’s review of its latest monetary policy statement says.
The central bank has been in the tightening mode for two years now and its interest rate-based targeting has been in force for one year. Inflation figures released every month speak for themselves how effective those steps were in controlling inflation. Will another round of monetary policy tightening bring inflation down to the central bank’s target, while keeping industrial sector growth on track?
The monetary policy statement (MPS) for the first-half (H1) of FY24 was announced on June 17 last year. The central bank has already been late by a month in announcing its MPS for the H1 of the new fiscal year. In this case, the later may be better.