Central banks across the world have been raising policy rates since the end of the past year to rein in bubbling inflation, fuelled by a splurge of money supply to stimulate life and livelihood. Almost all the major economies have hiked interest rates at least two to four times during the first nine months of the current calendar year, in the belt-tightening process. As inflation has hit multi-decade highs mainly due to high food and fuel prices caused by the Russian-Ukraine war, in lockstep with the pandemic, central banks have intensified their fights to curb the inflation by racheting up policy rates.
Federal Reserve, the central bank of the United States (US) which is the world's largest economy, started increasing interest in March. Since then, the Fed has enhanced the rate for five times to take it up to 3.25 per cent from zero-rated level. In May this year, the US annual inflation jumped to 8.6 per cent, the highest since December 1981. In the same month, Canada also experienced inflation of 7.7 per cent in an around 40-year high. So, the Bank of Canada also enhanced benchmark rate. All other major central banks, including the Bank of England, the European Central Bank, the Reserve Bank of Australia, and the Reserve Bank of New Zealand have raised policy rates several times in the current year. Central banks of developing countries like the Reserve Bank of India have also joined the global rate-hike rally.
Policy rate is the key tool of the central bank to operate its monetary policy and fight against inflation. Policy rate or benchmark rate is the rate central bank charges when commercial banks borrow from the central bank. If the central bank charges higher interest to commercial banks, they in turn enhance the interest rates they offer to borrowers, households and businesses. The result will be rise in cost of borrowing as the commercial banks increase the interest rates. So, personal loans, consumption credits, and mortgages will be more expensive and consumers will restrain their borrowing and spending. The monetary tightening ultimately leads to reduction in aggregate demand which tends to depress price inflation.
The International Monetary Fund (IMF) has identified food and energy as the main drivers of the ongoing global inflation which was generally moderating when the pandemic began, and the downward trend continued into the early months of the crisis. The surging prices since late 2020 have, however, pushed inflation steadily higher.
Now, the fight against inflation by the central banks through rate rise is heading for a deeper crisis: recession. Due to rate hike, financing becomes costlier and aggregate output goes on a downturn. This may, in the long run, turn into a massive contraction of economic activities and into a recession, at worst.
The United Nations Conference on Trade and Development (UNCTAD) in its Trade and Development Report 2022, released in the first week of this month, said that monetary and fiscal policy measures in advanced economies 'risk pushing the world towards global recession and prolonged stagnation, inflicting worse damage than the financial crisis in 2008 and the COVID-19 shock in 2020.' The UN body argued that any belief that the central banks would be able to bring down prices by relying on higher interest rates without generating a recession is 'an imprudent gamble'.
Three weeks before the UNCTAD released its flagship report, The World Bank had unveiled a research paper titled 'Is a Global Recession Imminent?' The paper argued that 'as central banks across the world simultaneously hike interest rates in response to inflation, the world may be edging toward a global recession in 2023.' It also added that a string of financial crises in emerging markets and developing economies may do them lasting harm. The World Bank further pointed out that the Russian invasion of Ukraine in February 2022 and associated international sanctions added to global inflationary pressures by further raising the prices of commodities-particularly energy and food-and by contributing further to global supply disruptions.
Thus the looming global recession becomes a matter of serious concern for the developing countries like Bangladesh which is now going through an excessive inflationary pressure coupled with slower economic output. Inflation jumped a decade high in August this year to 9.80 per cent from 7.49 per cent. It, however, dropped marginally to 9.30 per cent in September. Higher inflation means lager erosion of purchasing power. In fact, real income of most people entered a negative territory as their nominal income did not increase significantly.
Bangladesh Bank, to curb inflation, raised the repo rate (a key policy rate) for the third consecutive time in last five months, though modestly. Thus the rate hike has little impact to curb the wayward inflation which is fuelled by big rises in energy price August coupled with costlier imports. Moreover, by artificially keeping the deposit and lending rates fixed in banks at 6 per cent and 9 per cent respectively, the central bank has little to manoeuvre the policy rate and curb inflation, unless the caps are raised too.
With excessive inflationary pressure, there is also a sign of slowdown in aggregate demand as reflected in various proxy indicators like slowdown in private credit growth and drop in opening fresh letters of credit for importing capital machinery and intermediate goods.
Again, recession in the advanced economies will reduce the demand for goods imported from abroad. It will be a blow to developing countries like Bangladesh as their major export destinations are developed markets. Already, there is a sign of export slowdown in Bangladesh. In September, it dropped by 6.25 per cent. Remittance also declined by 10 per cent.
Though it is not possible to draw a conclusion from the ongoing economic developments that Bangladesh is also heading towards a recession in the near future, certainly a gloomy situation is already on the horizons.
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