MPS needs to encourage private sector investment along with containing inflation
Instead of focusing only on the policy rate to lower the money demand, interventions need to be made on the supply side as well. While interest rate hike can lower the inflation rate, it will make people’s lives more complex
The recently announced Monetary Policy Statement (MPS) prioritises curbing inflation, job creation, and maintaining GDP growth. The government has chosen a contractionary monetary policy to tame inflation, but at the same time, the development of the private sector was neglected.
The high private sector credit and output growth are positive signs for the economy. But, in the newly announced monetary policy, we can see a lower private sector credit growth target (14.1%) for the next fiscal year. It was 14.8% originally for the outgoing fiscal year.
We observed a rise in the private sector credit this year. At the end of May 2022, the year-on-year private sector credit growth was 12.94%, which was 7.55% in the corresponding period of the previous fiscal year.
During the first eight months of the current fiscal year, the large and medium-scale manufacturing output saw a 17.05% growth, which was 4.15% in the corresponding period of the previous fiscal year.
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Apart from the contractionary monetary policy, MPS targeted to minimise import dependency and save the foreign exchange reserve - BB declared to introduce a new refinance Line of Credit (LC) - which is a good initiative.
It is declared that the LC margin will be increased for luxury goods, canned and processed foods, non-cereal foods, and fruits to restrict their imports. Considering the volume of foreign exchange that will be saved, discouraging the import of these luxury products can prove to be rational; however, a segment of businesses and consumers could suffer. Small businesses are already suffering because of the high L/C margin.
Bangladesh Bank data shows that the inflation rate has increased from 6.29% in April to 7.42% in May this year. The year-on-year increase is 2.16%. The inflation rate was 5.26% in May 2021. Though we have not received the June rate yet, it can be assumed that it will remain high for the next couple of months.
Broad money growth is projected to rise to 12.1% in 2022-23 from 9.1% in 2021-22 as per the MPS. This means the cash supply in the economy will increase, which can positively impact real GDP in the short run.
A large part of this inflation crisis stemmed from global issues like production and supply chain disruption due to the Covid-19 pandemic and the Russia-Ukraine war. Before the war kicked off, the pandemic disrupted the supply chain and increased the demand for goods.
This situation pushed many countries to adopt accommodative monetary policies and expansive fiscal initiatives like stimulus packages. Bangladesh also announced a large amount of stimulus; however, distribution was uneven, and small investments suffered the most.
In a bid to keep the country's inflation rate under control, Bangladesh Bank increased its key interest rate also known as the policy rate, by 25 basis points to 5% at the end of May 2022., policy rate by 50 basis points to 5.5%. Earlier, the policy rate was 5%.
At the end of June 2022, BB increased the policy rate further. The Monetary Policy announced on June 30, 2022, sets a new policy rate of 5.50 % to check inflation by tightening the money flow.
With the high inflation rate, living costs are increasing in Bangladesh. Most importantly, basic food prices have gone up in recent months. The price hike of rice, the most valuable commodity in the Consumer Price Index(CPI), plays a significant role in food inflation. In a bid to decrease the price of rice, the government has cut the import duty on rice by 36.75%.
But it did not have the intended effect. We can see that the price of rice is still increasing. This food inflation is putting overwhelming pressure on the lives of ultra-poor, poor and middle-income people. Additional monitoring is needed in the distribution of essential goods.
A market economy operated in part or wholly by the laws of demand and supply can be impacted by any kind of shortage. All kinds of supply shortages will be reflected in the prices.
According to the Monetary Policy Statement 2022-23, increased price of food items like edible oil, vegetable, eggs and meat, and non-food items like transportation and communication, household furniture, clothing, and footwear were mainly responsible for the general inflation in FY 2022. These are also essential items, and duty cuts on these items can also be expected for the time being.
The Russia-Ukraine war intensifies the existing crisis created by the pandemic. As the global supply of gas, oil, wheat, fertiliser and so on are largely dependent on Russia and Ukraine, it pushes the price of energy and relevant goods higher in many countries.
After the Covid-19 situation improved: the aggregate demand responded faster than the aggregate supply. It pushed the energy and non-energy prices higher across the world.
Since the Covid-19 pandemic and the Russia-Ukraine war continue to disrupt the economy, BB will continue its support to implement the ongoing stimulus packages announced by the government.
Bangladesh is not immune to this demand-pull inflation. We are also facing demand-pull inflation due to the unresponsiveness in the supply of various commodities and goods to meet the excess demand. Experts say that factors like production bottlenecks, delivery delays, higher shipping costs, and scarcity of critical production inputs are mainly responsible for it. Sometimes cartelisation also creates supply shortages, which in effect creates demand-pull inflation.
We agree that if the monetary policy is loosened too much, it will risk the prices becoming even higher, further fuelling inflation. Raising the policy rate several times may help reduce the inflation rate. But at the same time, increased borrowing costs would further depress the credit growth, eroding private sector investment.
When the Federal Reserve Bank decided to raise the interest rate in the United States, renowned economist Joseph Stiglitz said that 'killing the economy through raising interest rates is not going to solve inflation in any timeframe.'
In a write-up published in the Project Syndicate, he said, ' my biggest concern is that central banks will overreact, raising interest rates excessively and hampering the nascent recovery. As always, those at the bottom of the income scale would suffer the most in this scenario.'
Instead of focusing only on the policy rate to lower the money demand, we also need to focus on supply-side interventions. An interest rate hike can indeed lower the inflation rate, but it will make people's lives more complex.
Our government can use structural and fiscal policies to ease the supply-side bottlenecks. Also, regulatory regimes can be streamlined and developed to unclog the supply bottlenecks.
The extra focus should be given to our labour market to compensate for the supply shortages. A skilled labour force can be helpful for the private sector's growth and for increasing overall supply.
Productivity-boosting technologies and artificial-intelligence-based tools can facilitate the overall supply chain of the country. Such initiatives can improve the balance between supply and demand. Without supply-side interventions, a policy rate increase disguised as a cure can be worse than a disease.
Ferdaus Ara Begum is CEO of BUILD, a PPD platform that works for private sector development
Mehedi Hasan is Sr. Research Associate of BUILD, a PPD platform that works for private sector development.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.
