Managing both inflation and growth in South Asia
Monday, 1 December 2008
Dr. Salehuddin Ahmed
While dealing with country-specific developments, it is to be noted that Afghanistan has been experiencing a big challenge in managing both inflation and growth. The current account balance showed a mixed trend over the years and is projected to deteriorate in 2009. The inflation rate is estimated at 24 per cent in 2008 compared with 13 per cent in 2007. This is mainly due to poor harvest, high food and fuel prices, and fragile law and order situation hampering movement of goods within the country. The growth rate of gross domestic product (GDP) has been estimated lower at 7.5 per cent in 2008 from 11.5 per cent in 2007.
Bangladesh achieved a growth rate of 6.2 per cent and a current account surplus of 0.9 per cent of GDP in fiscal year (FY) 08. The economy showed significant resilience in recovering from recurrent floods followed by cyclone (Sidr) during the year. The average Consumer Price Index (CPI) inflation moved up to 10.0 per cent in June 2008 mainly fed by supply-side factors dominated by high commodity prices in the international market and shortfall in domestic food grain production due to natural calamities. In response, among other measures, the government reduced import duties on food grains and other essential food items, introduced subsidized sales of food grains for the poor, and lowered interest rate on import credit in order to boost import of essential commodities. The Bangladesh Bank, the country's central bank, pursued growth supportive monetary policy stance permitting adequate flow of credit to agriculture, small and medium enterprises (SMEs), rural non-farm sector, and other productive activities. Private sector credit also expanded in other supportive areas such as transport and communications and working capital. For keeping demand-side pressures under control, the Bangladesh Bank relied on open market operations keeping reserve requirements, the liquidity ratio, and the main policy rate (reverse repurchase) unchanged for quite a while. The reverse repo rate has been increased recently by 25 basis points to 8.75.
In Bhutan, GDP growth rate rose to 17.0 per cent in 2007, pulled up largely by the start up of 1,020 megawatt Tala hydropower plant in end-June, 2007. Given the parity peg between the currencies of Bhutan and India, price movements of the two countries were similar, and in view of the price developments in India, Bhutan's projected inflation has been revised upward to 10.0 per cent in FY08.
Recent developments have created significant challenges to India's strong growth performance in recent years. Emerging capacity constraints, continued rapid expansion in credit, and partial pass through of global commodity price increases have triggered steep domestic inflation and consequently resulted in monetary tightening. The growth rate of GDP which was 9.0 per cent in 2007, is projected to fall to 7.4 per cent in 2008 and similar growth is likely to continue in 2009 as well. The inflation rate is also likely to pick up to 11.5 per cent in 2008 from 4.7 per cent in 2007. A widening trade deficit, moderating capital inflows, and some depreciation of Rupee also feature current developments. The main problem, however, stems from large fiscal imbalances created by escalating oil and other subsidies and other unbudgeted liabilities. The key to ensuring macroeconomic stability and unleashing the country's enormous growth potential lies on how well the government addresses the difficult budgetary issues in order to maintain macroeconomic stability and implement longer-term structural reforms.
Economic growth in the Maldives is estimated at 6.5 per cent in 2008. The consumer price index (CPI), reflecting the escalating costs of food and fuel, moved up to 15.5 per cent (year-on-year) in June 2008 raising the average inflation for the year to 11.0 per cent . Resulting mainly from expansionary fiscal policy, high import dependency, and rising fuel and food prices, the current account deficit widened to more than 40 per cent of GDP in 2007. These impacts seem to have strengthened in 2008 resulting in the deterioration of projected current account deficit to nearly 51 per cent of GDP.
The recent political developments in Nepal offer grounds for cautious hope. GDP growth rebounded to 5.6 per cent in 2008 from 2.6 per cent in 2007 supported by weather-induced recovery in agriculture. The growth revival was also aided by continued expansion of services activities. As a result of sharp increases in food and oil prices, year-on-year inflation rose to 7.9 per cent in 2008.
However, higher remittances and tourism receipts helped to more than offset the widening trade deficit to result in a current account surplus of 1.9 per cent of GDP (compared with a deficit of 0.1 per cent in the previous year).
The surge in global oil and food prices and domestic policy uncertainties within a turbulent political situation created heavy stress on the Pakistan economy in 2008. This was reflected in slowdown in growth, build-up in inflation, much larger fiscal and current account deficits, weakening currency, and large drop in foreign reserves. Increased risk perception was seen in downgrading of credit ratings, rise in sovereign bond spreads, slide in capital inflows, and declining access to international capital. With continued high oil prices, ongoing power shortages, and tightened demand management policies to correct macroeconomic imbalances, economic growth is estimated at 5.8 per cent in 2008. High inflation also persists averaging 12.0 per cent in 2008 as domestic fuel, food, and power subsidies are rationalized which is expected to rise further to 20 per cent in 2009 from 7.8 per cent in 2007.
Sri Lanka's economy grew by 6.8 per cent in 2007. Growth is forecast to be slightly lower at around 6.0 per cent in both 2008 and 2009 mainly due to the global slowdown affecting Sri Lanka's key export markets. Point-to-point inflation hit 15.8 per cent in December 2007, driven mainly by food prices. In 2008, the government increased fuel prices several times to allow pass-through of international oil price increases. Electricity tariffs were also revised in 2008, reflecting cost pressures on thermal power generation. This rise in administered prices contributed to pushing up inflation further reaching 28.2 per cent by end June 2008. Sri Lanka's balance of payments also remained under pressure largely due to high global oil prices. The current account deficit markedly widened and is projected to rise to 8.2 per cent of GDP in 2008.
Responses to rising inflation have varied across countries in South Asia. Some countries (e.g. India) tightened monetary policy by hiking interest rates and tightening reserve requirements. India also intervened in the foreign exchange market to support its currency. On the other hand, the fiscal policy stance was eased in many countries reflecting significant increases in food and fuel subsidies.
The above suggests that the economic cycle in South Asia started to turn especially since early 2008 and more weakness is expected ahead in response to slowing demand from developed country markets and growing stress in financial markets. In major South Asian economies, already there are signs of slowing growth in the situation of weakening investments while private consumption and export growth have held up well. The currencies have come under pressure prompting central banks to intervene in support (India and Pakistan). In several countries (e.g. India), underlying inflation pressures have increased as high resource utilization and robust credit growth have created favourable grounds for second round effects in the absence of sufficient policy tightening.
A major policy dilemma that the South Asian countries face at present is how to respond to the weakening growth outlook and global financial turbulence without losing sight of inflation risks that have deepened over the year. Overall, although there is considerable country divergences, downside risks to growth have risen while inflation risks have moderated in recent months as global food and fuel prices have declined. Accordingly, the South Asian countries need to adjust their policy priorities keeping in view notable differences in country circumstances.
The writer is Governor of Bangladesh Bank, the
central bank of the country
While dealing with country-specific developments, it is to be noted that Afghanistan has been experiencing a big challenge in managing both inflation and growth. The current account balance showed a mixed trend over the years and is projected to deteriorate in 2009. The inflation rate is estimated at 24 per cent in 2008 compared with 13 per cent in 2007. This is mainly due to poor harvest, high food and fuel prices, and fragile law and order situation hampering movement of goods within the country. The growth rate of gross domestic product (GDP) has been estimated lower at 7.5 per cent in 2008 from 11.5 per cent in 2007.
Bangladesh achieved a growth rate of 6.2 per cent and a current account surplus of 0.9 per cent of GDP in fiscal year (FY) 08. The economy showed significant resilience in recovering from recurrent floods followed by cyclone (Sidr) during the year. The average Consumer Price Index (CPI) inflation moved up to 10.0 per cent in June 2008 mainly fed by supply-side factors dominated by high commodity prices in the international market and shortfall in domestic food grain production due to natural calamities. In response, among other measures, the government reduced import duties on food grains and other essential food items, introduced subsidized sales of food grains for the poor, and lowered interest rate on import credit in order to boost import of essential commodities. The Bangladesh Bank, the country's central bank, pursued growth supportive monetary policy stance permitting adequate flow of credit to agriculture, small and medium enterprises (SMEs), rural non-farm sector, and other productive activities. Private sector credit also expanded in other supportive areas such as transport and communications and working capital. For keeping demand-side pressures under control, the Bangladesh Bank relied on open market operations keeping reserve requirements, the liquidity ratio, and the main policy rate (reverse repurchase) unchanged for quite a while. The reverse repo rate has been increased recently by 25 basis points to 8.75.
In Bhutan, GDP growth rate rose to 17.0 per cent in 2007, pulled up largely by the start up of 1,020 megawatt Tala hydropower plant in end-June, 2007. Given the parity peg between the currencies of Bhutan and India, price movements of the two countries were similar, and in view of the price developments in India, Bhutan's projected inflation has been revised upward to 10.0 per cent in FY08.
Recent developments have created significant challenges to India's strong growth performance in recent years. Emerging capacity constraints, continued rapid expansion in credit, and partial pass through of global commodity price increases have triggered steep domestic inflation and consequently resulted in monetary tightening. The growth rate of GDP which was 9.0 per cent in 2007, is projected to fall to 7.4 per cent in 2008 and similar growth is likely to continue in 2009 as well. The inflation rate is also likely to pick up to 11.5 per cent in 2008 from 4.7 per cent in 2007. A widening trade deficit, moderating capital inflows, and some depreciation of Rupee also feature current developments. The main problem, however, stems from large fiscal imbalances created by escalating oil and other subsidies and other unbudgeted liabilities. The key to ensuring macroeconomic stability and unleashing the country's enormous growth potential lies on how well the government addresses the difficult budgetary issues in order to maintain macroeconomic stability and implement longer-term structural reforms.
Economic growth in the Maldives is estimated at 6.5 per cent in 2008. The consumer price index (CPI), reflecting the escalating costs of food and fuel, moved up to 15.5 per cent (year-on-year) in June 2008 raising the average inflation for the year to 11.0 per cent . Resulting mainly from expansionary fiscal policy, high import dependency, and rising fuel and food prices, the current account deficit widened to more than 40 per cent of GDP in 2007. These impacts seem to have strengthened in 2008 resulting in the deterioration of projected current account deficit to nearly 51 per cent of GDP.
The recent political developments in Nepal offer grounds for cautious hope. GDP growth rebounded to 5.6 per cent in 2008 from 2.6 per cent in 2007 supported by weather-induced recovery in agriculture. The growth revival was also aided by continued expansion of services activities. As a result of sharp increases in food and oil prices, year-on-year inflation rose to 7.9 per cent in 2008.
However, higher remittances and tourism receipts helped to more than offset the widening trade deficit to result in a current account surplus of 1.9 per cent of GDP (compared with a deficit of 0.1 per cent in the previous year).
The surge in global oil and food prices and domestic policy uncertainties within a turbulent political situation created heavy stress on the Pakistan economy in 2008. This was reflected in slowdown in growth, build-up in inflation, much larger fiscal and current account deficits, weakening currency, and large drop in foreign reserves. Increased risk perception was seen in downgrading of credit ratings, rise in sovereign bond spreads, slide in capital inflows, and declining access to international capital. With continued high oil prices, ongoing power shortages, and tightened demand management policies to correct macroeconomic imbalances, economic growth is estimated at 5.8 per cent in 2008. High inflation also persists averaging 12.0 per cent in 2008 as domestic fuel, food, and power subsidies are rationalized which is expected to rise further to 20 per cent in 2009 from 7.8 per cent in 2007.
Sri Lanka's economy grew by 6.8 per cent in 2007. Growth is forecast to be slightly lower at around 6.0 per cent in both 2008 and 2009 mainly due to the global slowdown affecting Sri Lanka's key export markets. Point-to-point inflation hit 15.8 per cent in December 2007, driven mainly by food prices. In 2008, the government increased fuel prices several times to allow pass-through of international oil price increases. Electricity tariffs were also revised in 2008, reflecting cost pressures on thermal power generation. This rise in administered prices contributed to pushing up inflation further reaching 28.2 per cent by end June 2008. Sri Lanka's balance of payments also remained under pressure largely due to high global oil prices. The current account deficit markedly widened and is projected to rise to 8.2 per cent of GDP in 2008.
Responses to rising inflation have varied across countries in South Asia. Some countries (e.g. India) tightened monetary policy by hiking interest rates and tightening reserve requirements. India also intervened in the foreign exchange market to support its currency. On the other hand, the fiscal policy stance was eased in many countries reflecting significant increases in food and fuel subsidies.
The above suggests that the economic cycle in South Asia started to turn especially since early 2008 and more weakness is expected ahead in response to slowing demand from developed country markets and growing stress in financial markets. In major South Asian economies, already there are signs of slowing growth in the situation of weakening investments while private consumption and export growth have held up well. The currencies have come under pressure prompting central banks to intervene in support (India and Pakistan). In several countries (e.g. India), underlying inflation pressures have increased as high resource utilization and robust credit growth have created favourable grounds for second round effects in the absence of sufficient policy tightening.
A major policy dilemma that the South Asian countries face at present is how to respond to the weakening growth outlook and global financial turbulence without losing sight of inflation risks that have deepened over the year. Overall, although there is considerable country divergences, downside risks to growth have risen while inflation risks have moderated in recent months as global food and fuel prices have declined. Accordingly, the South Asian countries need to adjust their policy priorities keeping in view notable differences in country circumstances.
The writer is Governor of Bangladesh Bank, the
central bank of the country