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Surviving the meltdown

Fahmida Khatun and Abdullah Al Mahmood Mosfeq
In the backdrop of such a domestic scenario, major economies of the world have collapsed with severe credit crunch. Hence, Bangladesh Bank (BB) will need to perform a very careful balancing act in view of the need to control inflation and the need to stimulate investment at a time of global financial meltdown.
High inflation has been a major concern for the Bangladesh economy during the FY 2007-08. when inflation rate was higher compared to previous years due to several domestic and global factors. In the domestic arena, increase in food inflation has been due to lower food production as a result of two floods, a severe cyclone, and low stock of food.
Internationally too, prices of food items such as rice, wheat and soybean oil increased at a fast pace, breaking all past records. /Mong with this, prices of non-food items, including fuel oil and construction material, soared in the global market in FY 2007-08. The 12-month annual average rate of inflation increased to 10% in August2008 from 7.78% in August2007.
As food comprises about 59% of total Consumer Price Index (CPI) in Bangladesh, higher domestic food prices is the dominant factor for high inflation. While the government expects inflation rate to come down to 9% in FY 2008-09, the market is yet to see any downward inflationary trend. Money supply continues to increase, causing an increase in price level. As evidence shows, money supply (M2) went up by 17.48% during FY 2007-08 as opposed to 16.26% during FY2006-07.
A number of recent studies, including the one conducted by the Centre for Policy Dialogue (CPD), reveal that inflationary pressure during the FY 2007-08 has had an adverse impact on consumers through reduction of their purchasing power and income erosion. High inflation, particularly high food inflation, has affected the poor and the people in fixed income group. In this context, monetary sector is faced with the challenge of following a monetary policy that can control inflationary pressure, ensure poverty alleviation and accelerate economic development.
These objectives can only be achieved through sustainable output growth by channeling adequate resources into productive sectors of economy. A prudent monetary policy can play a vital role in resource allocation through the banking and financial system of the country.
In the backdrop of such a domestic scenario, major economics of the world have collapsed with severe credit crunch. Hence, Bangladesh Bank (BB) will need to perform a very careful balancing act in view of the need to control inflation and the need to stimulate investment at a time of global financial meltdown.
BB has to manage money supply in such a way that it does not squeeze die availability of funds for business and industry, which may affect employment and income in turn. There may be further increase in the money supply during the forthcoming national election.
Such expenditures are basically unproductive in economic terms and can lead to further inflationary pressure. This may also translate into increased government borrowing from banking and non-banking sectors.
During the last few years, government borrowing has been increasing. In FY 2007-08 government sector borrowing increased by 15%, compared to 12.1% in FY 2006-07, 14.5% in FY2005-06 and 11.1 % in FY2004-05.
Though external reliance of the Bangladesh economy is radier small, given the dynamic nature of the financial crisis, there may be an effect on the economy in various ways. Three sectors, financial, real and the labour market, could feel the pinch of the crisis.
It is apprehended that, in view of the global financial crisis, Bangladesh may experience reduction in export and remittance income. There could also be reduction in foreign investment and a cut in the aid flow.
Such circumstances call for domestic resource mobilisation through increased revenue collection and productive utilisation of resources. The dual approach of the government should, therefore, be to encourage public expenditure in productive capacities but limit unproductive spending, and guarantee adequate liquidity in the banks and ensure sufficient credit flow to the private sector to keep economic activities vibrant. As apprehension of a global economic recession, which may last for a few years, mounts, governments across the world are reducing interest rates to make funds available to people. As a response to the current financial crisis, BB could consider lowering of interest rate and explore the possibility of an expansionary monetary policy to avoid sluggishness in the economy.
This is not going to impact on the inflation since much of this inflation was due to high prices of imported commodities. With the rapid down turn of commodity prices inflationary pressure is expected to slow down. However, it is important to assess whether there is adequate demand for money.
Lower interest rate cannot increase credit flow unless there is a demand for money. The trend in the private sector borrowing does show that demand for credit is increasing. Though there was a decline in the private sector demand for credit in the beginning of FY 2007-08, partly due to uncertainty and fear in view of the changed governance framework and anti-corruption drive pursued by the interim government, the situation improved later when strong growth of the private sector credit was observed. Private sector borrowing increased by 24.2% in FY 2007-08, by 15.9 in FY 2006-07 and by 19% in FY2005-06.
Credit should flow to sectors such as agriculture, non-farm, and small and medium enterprises. Hence, effective demand in the rural areas has to be augmented too. In order to increase the productive capacities of these sectors the infrastructure has to be built up. Public expenditure on big infrastructural projects is crucial at the moment.
The exchange rate has also been an issue for the exporters, particularly in view of the currency depreciation against the US dollar in some neighbouring countries. At this juncture, countries may try to take advantage of each other on the issue of exchange rates. Special packages for the exporters are created in other countries, which may be considered in Bangladesh too.
The steps taken by BB in the face of financial meltdown have been quick and correct Bringing back the government investment from foreign banks and shifting its reserves from foreign banks have been the right decisions. Though the economy of Bangladesh is resilient to shocks of various types, there is no reason for being complacent. One must also take into account that the current shock is a systemic problem that has a structural dimension.
As election is approaching, it is high time for the political parties to devise their own economic plans and spell out their strategies to deal with the financial crisis during the run-up to tire elections. It is extremely important that, taking cognisance of the crisis right from the beginning, the new government pursues economic policies guided by adequate preparation and based on domestic realities.
Dr. Fahmida Khatun is the Additional Director and Abdullah Al Mahmood Mosfeq is a Programme Associate at the Centre for Policy Dialogue (CPD).