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Monetary policy for 'animal spirits'

Biru Paksha Paul
BANGLADESH Bank Governor
Atiur Rahman has recently announced monetary policy effective for the second half of fiscal 2013-2014 (FY14). Bankers and investors are particularly eager to see how the central bank outlines its monetary and financial stance that would be beneficial or detrimental to them. The amount of eagerness has been high this time, due to the apparent end of widespread violence in the name of political rights and the beginning of a new regime. And BB has struck the right note to stimulate 'animal spirits' among investors. The governor terms this stance as a cautious but investment friendly monetary policy.
The investment-GDP ratio, which is often defined as the investment rate, has remained in the doldrums in Bangladesh at around 24-26 percent for a decade or so. If the capital-output ratio in the region turns out to be 4, this investment rate is capable of generating output growth of 6 percent or slightly above. There are no other magical tools to earn and secure sustainable growth of 7 percent or above without increasing the investment-GDP ratio. In the last couple of years, Pakistan hardly managed a growth rate below 4 percent with its investment rate at around 13-14 percent.
In contrast, India registered 8 percent growth mainly because of its
high investment ratio at around 34-36 percent. And the same is true for China. Hence, BB’s investment focus along with the start of a new regime is the right music to play at this moment. Investors will receive this message enthusiastically.
While BB is sincere in its plan for capital formation and export promotion, its inflation management needs rigor and conservatism in the approach. Conservative money growth doesn't necessarily stifle investment growth in emerging economies where other institutional factors, such as bureaucracy and bribes, become big impediments in credit expansion.
It makes us curious when BB attempts to sell a 'cautious' monetary policy. The central bank must be always cautious to monitor the financial heartbeats of an economy, and as we believe, BB has always been so in the past. Now it’s time for BB to remain more watchful so inflation doesn't rear its ugly head as it did in the near past. In the FY2011-2012, average inflation exceeded the 10 percent mark.
Although inflation is now hovering over 7.5 percent, a target of 7 percent inflation by the end of this fiscal year will be hard to achieve if broad money growth is still indulged at 17 percent. Since Bangladesh is emerging and it requires huge foreign capital inflows to maintain this acceleration, the first thing the central bank
must ensure is macro stability in the economy.
Moderate inflation and price stability are the two most important indicators in this regard. While high inflation may encourage investors to pay less to the lenders in real terms and thus reap higher profits, it takes toll in consumption, which occupies 75-85 percent in national income. Hence, broad money growth, which directly increases inflation, should gradually come down to, say, 15 percent, to ensure a better macro stability for foreign investors and domestic consumers.
Of course, BB' apparatus has been successful in pulling inflation down particularly over the last two years, but the 12-month average of general inflation has been on the rise since January 2013 when it bottomed at 6.06 percent. A positive growth of inflation since then has been slow but steady, sending a sign of caution to the money printing press of the central bank.
If this trend continues, inflation will hit double digits in less than two years.
We argue that BB shouldn't have much problem in reducing money growth when commercial banks are sitting on idle cash. The banking sector had nearly Tk 83,000 crore in excess liquidity at the end of November. The amount was Tk 80,000 crore in July, according to newspaper reports. Let the banks exhaust that excess liquidity as investors' animal spirits kick off. A target of 16 percent reserve money growth, which is pivotal to determining broad money growth, seems ambitious and potentially inflationary. We expect that the BB governor will maintain his anti-inflationary reputation in the years to come.
At the end of the day, the substantial part of monetary policy's outcome lies in the kind hands of our politicians. If economists like Keynes and Friedman come out of their graves and formulate the best fiscal and monetary policy for Bangladesh, the 'animal spirits' of our politicians can easily min the results and can make it the worst ever.
Pakistan is an ideal example to illustrate how political vandalism can change the fortune of a potentially emerging country. Political unrest has eroded its growth for ages. While Pakistan's per capita income is still 1.5 times higher than Bangladesh's, the country lags behind Bangladesh in output growth for the last two decades. If this monetary policy can be tied with a responsible political behaviour, economic growth of 6 percent or even higher won't be difficult to achieve.
The author is associate professor of economics at the State University of New York at Cortland.