Food inflation remains a major concern******
Saturday, 7 May 2011
Mustafa K Mujeri concluding his two-part article
In Bangladesh, the most immediately recognizable causes of recent inflation are the coincident increase in food and other essential commodity prices. It is widely apprehended that the prices of both food and oil are likely to remain high in real terms for sometime in the world market. The 12 month point-to-point Consumer Price Index (CPI) inflation increased to 10.49 per cent in March 2011 from 7.26 per cent in July 2010, the steepest spike since July 2008. The rising inflation is mostly due to high food inflation which sharply rose to 13.87 per cent in March 2011 responding mainly to domestic market pressures and the tight supply-demand situation in the world market. Despite the likely sobering effect on rice prices due to upcoming good boro harvest, it is not clear how soon the rising food inflation can be tamed. Moreover, rising food inflation is a matter of concern especially in bringing overall inflation down since this may have some spillover effect on nonfood inflation as well. In addition, there exist other pressures which may fuel inflation in the coming months, such as strong domestic demand, high private sector credit growth, and rising consumer spending. There are multiple sources of demand pressure currently operating in the economy including historically observed destabilizing nature of fiscal policy fueled by sharp increases in current spending and inflow of remittances. In the domestic economy, good performance of agriculture (especially bumper aman and boro production) and manufacturing sectors would clearly help Bangladesh Bank (BB) in bringing inflation down from beyond its comfort level. With several favourable developments, the government also has a greater leverage on the domestic food grains market at present. Among others, the public food grain stock stood at 0.77 million tons in the third week of April 2011 which is well above the level during this time last year. The country imported 1.22 million tons of rice and 3.33 million tons of wheat till third week of April 2011 and more imports are in the pipeline to ease the supply situation. Although all these are positive developments, whether these would be adequate to bring down inflationary pressure in a sustained manner cannot be said with certainty. It is probable that the CPI inflation may continue with its upward trend over the next few months and only start to moderate during the end of 2011 in the absence of any unexpected shocks. In the face of these developments, BB's liquidity management in FY11 has to face two major challenges: first, injections from high fiscal deficit; and second, how to limit domestic liquidity at the programmed level in the face of strong credit demand by both public and private sectors. During July-February FY11, net borrowing of the government from the banking system stood at Tk 17.89 billion along with Tk 34.62 billion as net non-bank borrowing from the public. These figures were (-) Tk 92.65 billion and Tk 80.70 billion during the same period of the previous fiscal year. It would therefore be prudent for the government to keep the deficit within the budgeted amount. In recent months, worries about inflation have intensified in Bangladesh as elsewhere in Asia, and the possibility of further external shocks exist, most significantly resulting from continuing uncertainty in the Middle East and North Africa. The Bangladesh economy has already been hit by the events in Libya. If the conflicts spread to other countries in the region especially in the Gulf, then Bangladesh could be affected not just by rising oil prices but also by the slowing of remittances from Bangladeshi expatriates working in the area. Another major concern is whether BB's current efforts to maintain a stable economic environment is paying off. Central banks in most Asian countries seem to have opted to rely on a combination of stronger currencies and higher interest rates to temper a worsening inflation problem. Along with raising interest rates, most countries are using currency appreciation to help tackle inflation. It seems that the final tool in the armory of the region's central banks is FX appreciation and several countries have shown greater desire for currency appreciation to help tackle inflation. In the case of Bangladesh, Taka continued to depreciate in recent months. Several factors have contributed to excessive liquidity expansion in the economy during the current fiscal year. It would therefore be appropriate for BB to explore a combination of actions for managing the liquidity situation. In this respect, it would also be important to recognise that raising the policy rates is not likely to be very effective under the present situation. The experience of several countries in the region of using central bank policy rates and Cash Reserve Ratio (CRR) in containing domestic liquidity and inflation indicates that such measures are largely ineffective in the present situation. If interest rates are raised, growth is likely to be sacrificed. But this would not have much impact on inflation since supply side factors are clearly not within BB's control. In such a situation, demand side measures will pay little dividend with growth sacrificed needlessly. While the above may be true, it is important to recognise for policy purposes that although the root cause of current inflation lies in the supply side, the way inflation works is that, even if it has a supply side andor external source, it starts to feed on itself after a point. At the present juncture, inflation in Bangladesh seems to have reached a similar situation. At this stage, BB needs to give a clear signal and ensure that high inflation does not enter into the mediumlong term expectations of the economic agents. If relatively high inflation is taken for granted, inflation would become a vicious cycle of its own. It is true that the shocks came from outside the monetary system, but what BB can do is to use its tools to contain it and ensure that it does not become a permanent feature. With high food and oil prices in the global market, the issue of equity also comes to the forefront in terms of shouldering the burden of fighting globally generated inflation by raising interest rates and reducing growth by the less developed countries like Bangladesh vis-à-vis the policies of the developed countries. As a preemptive measure to limiting liquidity expansion, BB has raised the CRR and Statutory Liquidity Ratio (SLR) as well as the repo and reverse repo rates several times during FY11. In its latest move, BB raised its policy interest rates by 25 basis points (repo rate to 6.25 percent and reverse repo rate to 4.25 per cent) in late April 2011. The expectation was that these measures would make loans expensive and thus contribute to meeting the monetary policy objectives through curbing credit growth and correcting the short-term debt yield curve. The rate hikes were viewed as timely by BB to convey its intention of limiting undesired credit expansion and achieving the target domestic credit growth as programmed in the annual monetary program of FY11. Additionally, this was expected to contribute toward 'planning for tomorrow' especially in terms of dampening inflation expectations and moving toward price stability. However, the expectations seem to have remained largely unrealized indicating the ineffectiveness of these tools under the present situation. Moreover, the credibility of the monetary programme and the underlying targets has come under question along with BB's inability to take timely measures. In view of the above, BB is required to proceed with a combination of measures using appropriate instruments. Some possible actions could be as follows: l Continue with the practice of keeping a close watch on monetary developments especially the flow of credit to different sectorsactivities. The intention would be to ensure the flow of adequate credit to productivepriority sectors, and discourage credit flows to non-essential and speculative uses. If necessary, BB could take appropriate measures such as imposing higher general provision requirement on such loans to achieve the desired goals. l Monitor the outcome of the increase in the policy rates and allow adequate time for the effects of the rate hikes to be fully realized. l In view of the close links in the movement of net domestic assets (NDA) and net foreign assets (NFA) and their pronounced seasonal characteristics, monitor their movements in tandem and take measures (e.g. through buyingselling of foreign exchange in the inter-bank market) to maintain reasonable exchange rate stability. l Use instruments, such as repo, reverse repo, and BB bills more frequently as and when needed to manage liquidity in a prudent manner. l Encourage the banks to divert increasing amount of remittances to investment in productive sectors. The success of the policy actions would require greater fiscal and monetary coordination to ensure clear recognition of the importance of the monetary policy stance and appropriate alignment of relevant policy parameters within the overall macroeconomic framework. In addition, bringing appropriate changes in the government's debt management strategy would be important to improve the balance between short and long term borrowing since any shift in the borrowing pattern has implications for the conduct of monetary policy. Despite the fact that the outlook for growth remains buoyant, the persistence of inflationary pressure led by stubbornly high food inflation remains a major concern for the present. No doubt, high inflationary expectations pose a complex challenge for the conduct of monetary policy by BB. Further, the challenge is exacerbated by the fact that inflationary pressures are emanating from sources that are not very sensitive to monetary policy measures. Another danger is that the current environment of high food inflation raises the risk of spillover to nonfood inflation through higher costs and inflationary expectations. In the current regime of dominance of structural factors underlying inflationary forces, the impact of anti-inflationary monetary policy is likely to remain dampened. Despite these limitations, the prime concern of BB's monetary policy at present should focus on containing inflation since persistence of high inflation could endanger growth and amplify risks to inclusive growth. Dr. Mustafa K Mujeri is the Director General of Bangladesh Institute of Development Studies
In Bangladesh, the most immediately recognizable causes of recent inflation are the coincident increase in food and other essential commodity prices. It is widely apprehended that the prices of both food and oil are likely to remain high in real terms for sometime in the world market. The 12 month point-to-point Consumer Price Index (CPI) inflation increased to 10.49 per cent in March 2011 from 7.26 per cent in July 2010, the steepest spike since July 2008. The rising inflation is mostly due to high food inflation which sharply rose to 13.87 per cent in March 2011 responding mainly to domestic market pressures and the tight supply-demand situation in the world market. Despite the likely sobering effect on rice prices due to upcoming good boro harvest, it is not clear how soon the rising food inflation can be tamed. Moreover, rising food inflation is a matter of concern especially in bringing overall inflation down since this may have some spillover effect on nonfood inflation as well. In addition, there exist other pressures which may fuel inflation in the coming months, such as strong domestic demand, high private sector credit growth, and rising consumer spending. There are multiple sources of demand pressure currently operating in the economy including historically observed destabilizing nature of fiscal policy fueled by sharp increases in current spending and inflow of remittances. In the domestic economy, good performance of agriculture (especially bumper aman and boro production) and manufacturing sectors would clearly help Bangladesh Bank (BB) in bringing inflation down from beyond its comfort level. With several favourable developments, the government also has a greater leverage on the domestic food grains market at present. Among others, the public food grain stock stood at 0.77 million tons in the third week of April 2011 which is well above the level during this time last year. The country imported 1.22 million tons of rice and 3.33 million tons of wheat till third week of April 2011 and more imports are in the pipeline to ease the supply situation. Although all these are positive developments, whether these would be adequate to bring down inflationary pressure in a sustained manner cannot be said with certainty. It is probable that the CPI inflation may continue with its upward trend over the next few months and only start to moderate during the end of 2011 in the absence of any unexpected shocks. In the face of these developments, BB's liquidity management in FY11 has to face two major challenges: first, injections from high fiscal deficit; and second, how to limit domestic liquidity at the programmed level in the face of strong credit demand by both public and private sectors. During July-February FY11, net borrowing of the government from the banking system stood at Tk 17.89 billion along with Tk 34.62 billion as net non-bank borrowing from the public. These figures were (-) Tk 92.65 billion and Tk 80.70 billion during the same period of the previous fiscal year. It would therefore be prudent for the government to keep the deficit within the budgeted amount. In recent months, worries about inflation have intensified in Bangladesh as elsewhere in Asia, and the possibility of further external shocks exist, most significantly resulting from continuing uncertainty in the Middle East and North Africa. The Bangladesh economy has already been hit by the events in Libya. If the conflicts spread to other countries in the region especially in the Gulf, then Bangladesh could be affected not just by rising oil prices but also by the slowing of remittances from Bangladeshi expatriates working in the area. Another major concern is whether BB's current efforts to maintain a stable economic environment is paying off. Central banks in most Asian countries seem to have opted to rely on a combination of stronger currencies and higher interest rates to temper a worsening inflation problem. Along with raising interest rates, most countries are using currency appreciation to help tackle inflation. It seems that the final tool in the armory of the region's central banks is FX appreciation and several countries have shown greater desire for currency appreciation to help tackle inflation. In the case of Bangladesh, Taka continued to depreciate in recent months. Several factors have contributed to excessive liquidity expansion in the economy during the current fiscal year. It would therefore be appropriate for BB to explore a combination of actions for managing the liquidity situation. In this respect, it would also be important to recognise that raising the policy rates is not likely to be very effective under the present situation. The experience of several countries in the region of using central bank policy rates and Cash Reserve Ratio (CRR) in containing domestic liquidity and inflation indicates that such measures are largely ineffective in the present situation. If interest rates are raised, growth is likely to be sacrificed. But this would not have much impact on inflation since supply side factors are clearly not within BB's control. In such a situation, demand side measures will pay little dividend with growth sacrificed needlessly. While the above may be true, it is important to recognise for policy purposes that although the root cause of current inflation lies in the supply side, the way inflation works is that, even if it has a supply side andor external source, it starts to feed on itself after a point. At the present juncture, inflation in Bangladesh seems to have reached a similar situation. At this stage, BB needs to give a clear signal and ensure that high inflation does not enter into the mediumlong term expectations of the economic agents. If relatively high inflation is taken for granted, inflation would become a vicious cycle of its own. It is true that the shocks came from outside the monetary system, but what BB can do is to use its tools to contain it and ensure that it does not become a permanent feature. With high food and oil prices in the global market, the issue of equity also comes to the forefront in terms of shouldering the burden of fighting globally generated inflation by raising interest rates and reducing growth by the less developed countries like Bangladesh vis-à-vis the policies of the developed countries. As a preemptive measure to limiting liquidity expansion, BB has raised the CRR and Statutory Liquidity Ratio (SLR) as well as the repo and reverse repo rates several times during FY11. In its latest move, BB raised its policy interest rates by 25 basis points (repo rate to 6.25 percent and reverse repo rate to 4.25 per cent) in late April 2011. The expectation was that these measures would make loans expensive and thus contribute to meeting the monetary policy objectives through curbing credit growth and correcting the short-term debt yield curve. The rate hikes were viewed as timely by BB to convey its intention of limiting undesired credit expansion and achieving the target domestic credit growth as programmed in the annual monetary program of FY11. Additionally, this was expected to contribute toward 'planning for tomorrow' especially in terms of dampening inflation expectations and moving toward price stability. However, the expectations seem to have remained largely unrealized indicating the ineffectiveness of these tools under the present situation. Moreover, the credibility of the monetary programme and the underlying targets has come under question along with BB's inability to take timely measures. In view of the above, BB is required to proceed with a combination of measures using appropriate instruments. Some possible actions could be as follows: l Continue with the practice of keeping a close watch on monetary developments especially the flow of credit to different sectorsactivities. The intention would be to ensure the flow of adequate credit to productivepriority sectors, and discourage credit flows to non-essential and speculative uses. If necessary, BB could take appropriate measures such as imposing higher general provision requirement on such loans to achieve the desired goals. l Monitor the outcome of the increase in the policy rates and allow adequate time for the effects of the rate hikes to be fully realized. l In view of the close links in the movement of net domestic assets (NDA) and net foreign assets (NFA) and their pronounced seasonal characteristics, monitor their movements in tandem and take measures (e.g. through buyingselling of foreign exchange in the inter-bank market) to maintain reasonable exchange rate stability. l Use instruments, such as repo, reverse repo, and BB bills more frequently as and when needed to manage liquidity in a prudent manner. l Encourage the banks to divert increasing amount of remittances to investment in productive sectors. The success of the policy actions would require greater fiscal and monetary coordination to ensure clear recognition of the importance of the monetary policy stance and appropriate alignment of relevant policy parameters within the overall macroeconomic framework. In addition, bringing appropriate changes in the government's debt management strategy would be important to improve the balance between short and long term borrowing since any shift in the borrowing pattern has implications for the conduct of monetary policy. Despite the fact that the outlook for growth remains buoyant, the persistence of inflationary pressure led by stubbornly high food inflation remains a major concern for the present. No doubt, high inflationary expectations pose a complex challenge for the conduct of monetary policy by BB. Further, the challenge is exacerbated by the fact that inflationary pressures are emanating from sources that are not very sensitive to monetary policy measures. Another danger is that the current environment of high food inflation raises the risk of spillover to nonfood inflation through higher costs and inflationary expectations. In the current regime of dominance of structural factors underlying inflationary forces, the impact of anti-inflationary monetary policy is likely to remain dampened. Despite these limitations, the prime concern of BB's monetary policy at present should focus on containing inflation since persistence of high inflation could endanger growth and amplify risks to inclusive growth. Dr. Mustafa K Mujeri is the Director General of Bangladesh Institute of Development Studies