Inflation and economic growth

Investors come across terms like inflation and gross domestic product (GDP) just about every day. They are often made to feel that these metrics must be studied as a surgeon would study a patient's chart prior to operating. The terms do lend some idea of what they mean and how they interact, but what do we do when the best economic minds in the world can't agree on how much an economy should grow, or how much inflation is too burdensome for the financial markets to bear? Individual investors need to find a level of understanding that assists their decision-making without being inundated by piles of data.
The relationship between inflation and economic output (GDP) is a very delicate one. For stock market investors, annual growth in the GDP is vital. If overall economic output is declining or merely holding steady, most companies will not be able to increase their profits, which is the primary driver of stock performance. However, too much GDP growth is also dangerous, as it is most likely to be accompanied by an increase in inflation, which erodes stock market gains by making money (and future corporate profits) less valuable. Most economists today agree that 2.5-3.5 per cent GDP growth per year is the most that our economy can safely maintain without causing negative side effects. But where do these numbers come from? In order to answer this question, we need to bring a new variable, unemployment rate, into play.
Studies have shown that over the past 20 years, annual GDP growth over 2.5 per cent has caused a 0.5 per cent drop in unemployment for every percentage point over 2.5 per cent. It sounds like the perfect way to kill two birds with one stone -- increasing the overall growth while lowering the unemployment rate.
In Bangladesh, the government was successful in restricting the rate of inflation to 7.0 per cent during the last fiscal. A recent report reveals that the overall rate of inflation during August 2014 was 6.91 per cent compared to 7.04 per cent during the preceding month. The downward trend, although temporal, was an encouraging development. Inflation in non-food items was 7.39 per cent last year. Inflation actually went down in last June, but July being the month of Ramadan, experienced sharp rises in commodity prices. Such increase in product prices created cost-pushed inflation as well as demand-pushed inflation, or demand-pull inflation.
To make the government's endeavour for financial inclusion successful, it is imperative that higher employment opportunities be generated and purchasing power enhanced. With this end in view, the focus should be on industrialisation. As a developing country, Bangladesh needs capital-intensive industries to forge ahead towards building a strong economy. In other words, we need both import-substitution as well as export-oriented industries. As a country aspiring to become a middle income state, the focus should be equally on capital-intensive as well as labour-intensive industries.  
Bangladesh now has many millionaires but not all them pay annual taxes. The government, therefore, has no other choice but to impose indirect taxes for realising the money required to run the affairs of the state. This year the government has imposed super tax. In order to harness economic development and honour people's rights, direct tax is certainly better than indirect taxes. If revenue collected matches revenue expected, government is not required to borrow from banks. Government borrowings encourage inflation in one way or the other. The point that is to be noted here is, whether the loan is being spent for productive or for non-productive purposes. If spent for non-productive purposes, it will naturally push inflation up. Again, if money for investment is borrowed from non-institutional sources at a high rate of interest, it will trigger inflation. The interest paid to the government by the banks and financial institutions or in other words, by the financial sector, reduces the possibility of any reduction in inflation. According to Carmen Reinhart and Kenneth Rogoff theory, if government borrowing is high, growth rate will go down. The Reinhart and Rogoff theory may be argued, but if it is considered partly true, inflation occurs when non-development expenditures are high.    
Bank borrowing by the government is another source of inflation. Thankfully, government borrowings during the last fiscal were less compared to four previous years because of mainly two reasons. First, higher sale of savings certificates; and second, moderate rate of ADP implementation in eleven months up to January 2014. The scenario slightly improved in June and the planning minister expressed optimism that 96 per cent of last year's ADP will be achieved.
The process of ADP implementation should be modernised and made more systematic in order to achieve and maintain steady growth. Month-wise implementation target should be set and management change required for achieving the targets should be brought about. While we talk about timely implementation, it is also true that hasty implementation can not guarantee quality of work. On the contrary, it causes wastage and thereby induces rising inflation.
The economy is expanding. At the same time, administrative expenses are also rising. Due to increased administrative expenses, non-development expenditures were higher than development expenditures during the current fiscal, which encouraged inflation.  
Production of food crops increased during the last three years. While it is a commendable feat, care should be taken for increased production of other agricultural products and further diversification in the agriculture sector. At the same time, effort should be made to reduce dependence on imported agricultural products, like, pulses, onion, ginger, soybean etc., to name a few. Apart from achieving higher production in food and other agricultural products, supply management for the same will have to be enhanced for businesses to flourish. Accordingly, marketing system will also have to be improved to ensure speedy delivery of food materials to the consumers.

The writer is a TV personality and writes on economic issues.
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