Bangladesh Bank has issued its Monetary Policy Statement July - December 2010

(MPS). In fact the forecasts cover the economy for the entire financial year July 2010
- June 2011 and none of the quantitative forecasts correspond to the six months
period. As usual this statement is well presented but conveys the usual obscure
objective of trying to square the circle, reduce inflation and increase the growth rate
at the same time. The basic relationship, if there is one, between unemployment
[i.e. economic growth in the short run] and inflation controls central bank behaviour.
Some central banks have their objective as limiting the level of inflation. They take
appropriate action without concern for employment or growth. Other central banks
like Bangladesh Bank and the US Federal Reserve are handed a statutory objective
of trying to achieve both. The best we know if you reduce inflation you slow growth
and if you raise growth you raise inflation. This trade off is clearly present in
Bangladesh but no one wants to deal with its implications. The latest MPS continues
to proclaim that one can achieve both. However, there is little convincing argument
to tell us how the central bank will accomplish this overall objective. In fairness to
Bangladesh Bank one should separate the words from the deeds and the central
bank has committed itself to an inflation reducing course.
The mechanism for the trade off between growth and inflation works in many ways
but the dominant channel in Bangladesh is through the exchange rate: If the
exchange rate is depreciated exports will increase and imports will decrease leading
to more domestic output using underemployed labour and capital in Bangladesh.
But if the Taka is weaker prices are higher. Bangladesh food prices are particularly
vulnerable to changes in the Taka-Indian rupee exchange rate due to the proximity
of the markets. In setting monetary policy one has to choose where on the growth-
inflation trade off one wants to be. [This is a short run choice and has little to do
with long term growth]. The MPS could take a stand to support rapid growth [6.7 per
cent is rapid] and to force the Taka to depreciate to achieve such an outcome; or
the MPS could aim at a 4-5 per cent inflation rate and forcing a slow down of the
growth of the private sector. The choice that has been made is the second of these-
allowing the balance of payments to weaken while limiting the growth of the money
supply to contain inflation.
We cover three points:
- What does the MPS tell us that BB expects of the economy?
- What changes in money and credit, exchange rate and interest rates are
expected?
- Are the monetary policy instruments able to accomplish the changes?
What does the MPS tell us that BB expects of the economy?
The outcome of the economy in 2010/11 will depend on external factors,
agriculture, fiscal policy and monetary policy. The outcome is measured by GDP
growth and inflation. The logic of the Monetary Policy Statement presentation is all
tangled up. I try to untangle these ideas. The actions of the central bank are in
principle independent of the Government; this independence has strengthened in
the past few years and this financial year will provide an interesting test. The MPS
will soon fly in the face of the Government's wish for more expansionary monetary
policy and we shall see if the central bank sticks to its objectives.
The key elements driving the economy from the external sector are: Exports,
remittances, foreign direct investment and foreign aid. The central bank expects the
nominal exchange rate with the dollar to be steady. Bangladesh Bank manages the
exchange rate to keep it from appreciation which it would without BB's regular
intervention. The central bank is silent on the real exchange rate, i.e. the nominal
exchange rate corrected for the different rates of inflation. As the expected inflation
rate is greater than that of the major traders and the Euro may depreciate we have
a probable appreciation of the Taka in real terms. If this is the correct view of the
real exchange rate then this is consistent with the idea that BB is probably leaning
towards reduced inflation and slower growth although nowhere is this admitted. The
behaviour of the real exchange rate is one critical indicator of the choice between
inflation and growth.
For exports BB expects an increase of 10.4 per cent to $17.8 billion over $16.1
billion in 2009/10. This is a perfectly good if it is a conservative forecast. There are
some ideas presented relevant to long run growth of exports with wishful thinking
about new trading partners and international agreements; these are good things to
aim for but are distant. There are many things that will increase in the short run but
BB does not focus on these. There are several potential downside risks in the export
forecast:
A. The world economy may not recover strongly; in particular the European
countries may show weaker growth and the Euro may depreciate with respect to
the dollar. These will slow export growth. In mid 2010 the world economy seems to
be doing quite well, but most observers claim that there is some chance of a weaker
performance.
B. The labour conflicts and energy shortages may result in reduced apparel
production and consequently exports. The export forecast presented by BB does not
provide the commodity details but the implied forecast performance of the garment
sector should be 8-10 per cent. The MPS does state an opinion on the question of
the minimum wage taking the side of the workers in the critical garment sector. The
remarks on wages and the garment sector surprisingly show no recognition at all of
the cost structure of the industry, the pricing of garment exports and the
implications of a generous wage award. If BB is correct that rural wages have risen
above garment sector wages then the stagnation of wages in the garment sector
indicates that the labour provided to the garment sector should shrink and labour
should shift to agriculture. This is one of many examples of the MPS where markets
are ignored and replaced with naïve ideas about social justice. However, if this view
of the relative wages is correct then the wage rates in the garment sector will rise
on their own and the industry will shrink in output. The nexus of rural and urban
wages and the labour supply is an important issue that deserves much more work
by the central bank. Indeed this statement in the MPS is probably the most
important indicator of how the economy is evolving. Bangladesh is it seems moving
into a condition of labour shortage.
C. Another downside factor arises for shrimp exports which face problems arising
from quality issues, labour disputes in the processing plants and environmental
disputes at the farm level. These disputes go on and on without resolution.
Everyone has suffered in this sector due to an inability to untangle and enforce the
quality standards. Government after Government has failed to put in place the
facilities that would enable this sector to grow rapidly. During the next year the
ability of the industry and government to manage these quality issues could cause a
significant increase in shrimp exports or more likely a sharp reduction.
D. The final downside risk in the garment sector is found in the leather and leather
products industries. This sector continues to stagnate unable to resolve the
extremely serious environmental issues. The tremendous potential of this sector is
not being achieved. While it is not the BB's job to deal with this problem one should
recognize that export growth could be greatly increased with a real effort by
Government to resolve issues that have dragged on for years. Equally the sector
may do less well than expected as the environmental problems mount with no
resolution.
Even admitting these downside risks I believe the BB export forecast is on the
conservative side. The trend growth for exports is about 12 per cent; the past
financial year showed a very low growth of about 3 per cent over the previous
financial year. We would expect, as the world economy is recovering, export growth
would be much faster, rising above the trend. This is what is happening in other
countries. Hence export growth of 15-16 per cent seems to me more likely. The MPS
might have managed to criticize the Government for the lack of interest in serious
efforts to diversity and accelerate export growth. The budgets efforts in this regard
were at best modest. The stronger performance of exports suggested here would
increase exports by another billion dollars.
Remittance growth is projected to increase by 16 per cent to $12.9 billion from
$11.1 billion in 2009/10. This is again a reasonable forecast; there are the well
known downside risks of fewer workers being accepted in the Gulf States. But these
are probably exaggerated and if true will have long run rather than short run
effects.
Foreign direct investment is projected to stay more or less the same at $700
million, so BB sees no improvement in the FDI inflow. The general stance of the
Government has been to discourage foreign investment. In the energy sector there
is no actual progress in increasing foreign investment in the gas or the electricity
generating sectors. In telecommunications the recent legislation will in the view of
the industry seriously discourage foreign investment. The new economic zones
legislation will confuse everyone with respect to the position and role of the export
processing zones. Altogether the signals to the potential foreign investors are not
positive. Despite all of these negative ideas the prospects for the Bangladesh are
good, the commitment to democracy positive, and the growing economic ties with
India are factors that impress foreign investors. One can be more optimistic about
the inflows of foreign investment.
Foreign aid is projected at $2.8 billion gross compared to $2.3 billion in 2009/10.
The donor community is supportive of the government but finds it slow and difficult
to deal with the Ministries. There is a surprising distrust between Government and
donors. Bangladesh one of the poorest countries in the world with massive poverty
receives little foreign assistance on a per capita basis, only $17. BB is certainly
correct that this is not going to change much. Indeed past Governments have seen
foreign aid as a displacement of private sector activity; these inflows have enabled
the Government to expand what they are doing in many instances displacing the
private sector.
We can examine the impact of expected exports and remittances on growth: The
increase of exports forecast by BB is $1.7 billion of which half is imported
components; combining this with the increase of remittances of $1.8 billion,
weighted by estimated multipliers we have an expansion of $6.1 billion including in
the estimated multipliers an estimated deficit of 2 per cent of GDP financed
domestically. This corresponds to an expansion of GDP of 6.5-7.0 per cent
consistent with the Budget forecast. Using the more realistic estimates of exports
and imports the economy should grow 7.0-7.5 per cent. Most commentators have
found the growth target ambitious; but I think it is rather modest. Bangladesh Bank
has correctly found the Budget target growth rate consistent with their picture of
the economy.
Bangladesh Bank through its lending programme is supporting more rapid growth in
agriculture though major increases in availability of bank finance in rural areas. This
programme is both potentially successful and also dangerous. It is successful if it
raises output and increases wages in step with productivity increases. But the
increase in rural credit is one factor contributing to the higher wages in rural areas
and hence putting pressure on the garment sector. This increase in agricultural
credit is a good idea if the agricultural loans have an impact on production, raising
labour productivity; but it is a very bad idea if there is no consequent increase in
labour productivity, resulting in poor loan recovery. This is a very risky policy as it
may not help farm labour productivity, but will harm the competitiveness of the
garment sector. I do not think BB appreciates how risky this policy really is. To make
it successful the farmers must improve their technologies using better quality
seeds, improving agronomic practices, and improving the fertilizer mix. The
ultimate test will be the real level of loan recovery. The rules for determining NPLs
in the agricultural sector are not as rigorous as for other loans in trading and
manufacturing, so the real loan recovery situation is likely to be less than
transparent. There is a considerable improvement in the rural sector and rising rural
wages seem to be a real phenomena but it is dangerous to throw kerosene on this
fire with loans that do not lead to higher labour productivity than would otherwise
have been achieved.
The Government expenditure programme as reflected in the 2010/11 budget is
ambitious and the deficit is expected to be around 5 per cent of GDP; although a
large part of this will be financed through foreign assistance there will be a
significant increase in borrowing from the banking sector! This greater deficit in
2010/11 will be an expansionary factor unlike 2009/10 when the low deficit was
almost neutral.
All of these growth driven factors, BB believes, will validate the forecast increase in
GDP of 6.7 per cent forecast in the Budget presentation or even higher. Will such
expansion cause inflation? Can BB control inflation with such an increase of output?
That is the key question before the monetary authorities.
The result of the greater GDP growth rate, BB believes, will be a sharp increase in
imports which are projected to increase 18 per cent compared to 2.5 - 3 per cent for
2009/10. This forecast is very high. Past import increases have reached such rates
only when commodity prices are rising. BB does not tell us in the MPS what is
assumed. But this rate of import increase is probably too high.
The current account surplus is projected to drop to $1 billion from $3.2 billion in
2009/10. The international financial transactions come out according to BB with
almost no change of a net outflow. However, including errors and omissions the out
flow of capital will increase from about $400 million to $700 million. To be clear
Bangladesh Bank projects the current account will be in surplus but the capital and
financial accounts will be in deficit resulting from a net outflow of capital to the rest
of the world.
Hence Bangladesh Bank projects the balance of payments surplus will decline to
$358 million from $2.779 billion in 2009/10. In a nutshell faster economic growth
will result in greater imports and sharply reduce the balance of payments surplus.
There is little discussion in the MPS of changes in domestic private investment. The
linkage to monetary policy is discussed below. The level of private investment is not
discussed in the MPS.
The impetus to growth is expected to come from the agricultural sector and the
industrial sector. On the demand side one assumes that BB believes that the
expected increases in Government expenditures will more than offset the decline of
the current account surplus. q