MCCI urges govt to relax monetary policy, reduce bank borrowings
Friday, 14 September 2007
FE Report
The Metropolitan Chamber of Commerce & Industry (MCCI) has called upon the government to urgently review and relax the monetary policy and reduce its own borrowings from the banking sector.
"The key to price stability lies in greater productivity from investments in plant, property, equipment and people. This can occur only in a regime of lower short and long term interest rates", according to the MCCI, the country's leading chamber body.
In an editorial comment in its latest monthly -- Chamber News -- the MCCI said: "Despite sincere efforts by the government to contain the price spiral through various administrative and budgetary measures, the same continues to rise unabated.
"According to BBS data, the overall inflation rate on point-to-point basis in July 2007 stood at a 10-year high of 10.20 per cent. In June it was 9.20 per cent. Food inflation on point-to-point basis was 11.0 per cent in July, which was 9.82 per cent in June. Inflation of non-food items in July was 10.0 per cent, which was 9.34 per cent in June", it added.
It noted: "Higher domestic and international prices of essential products like food and fuels, depreciation of the Taka, increase in the administered prices of petroleum products by 21-33 per cent in April last to bring them closer to world prices, and the lack of proper supply management have contributed to the price spiral.
"We appreciate the Government's efforts to ease down the prices of the essential products by such means as monitoring markets, opening wholesale centres and retail outlets, and reducing import duties on certain products, but these ad hoc measures are essentially temporary and cannot be expected to cater to the demands of a wider population and reduce price pressure unless the supply situation can be improved through imports and increased domestic production.
Inflation in Bangladesh, it said, has been predominantly of a cost-push variety, which discourages production. A solution of this problem will require not just the pure monetary theory approach, but a strategy for removal of supply bottlenecks and increased production and productivity in all productive sectors of the economy.
It observed: "Milton Friedman's argument that inflation is essentially a monetary phenomenon has proved to be incorrect in many countries, including in his own, the United States."
In its commentary, the MCCI recalled the situation in the United States during the 1970s and 1980s while pointing out that the supply-side economic policies of the Reagan-Bush era (1980-1992) were successful in stopping the persistent inflation and stabilising prices. "Lower interest rates were brought about to permanently wring inflation out of the economy".
It said: "The resurgence in American manufacturing was largely due to cheaper long-term financing for new plants and equipments. Consumers and workers also benefited greatly from the low-interest policy. The decline in interest rates on consumer loans to finance purchases of automobiles and consumer durables was a key factor in maintaining overall economic growth. A stable price environment that resulted from the Federal Reserve's easy money policy allowed both lenders and borrowers to engage in profitable transactions that facilitated consumption and increased the pool of private investment capital. Bangladesh policy makers can derive lessons from this example."
It further said: "Historical experience of many other countries, too, shows that monetary approach practised by them generated significant economic costs -- slow growth, falling investment, job losses, and high real interest rates. The adoption of tight monetary policy focusing on lowering the rate of inflation, with little regard to its impact on "real variables" such as employment, investment and growth, cannot, therefore, be appropriate.
"Empirical research has not found any correspondence between changes in money supply and the rate of inflation in Bangladesh. In the late 1980s, the Bangladesh Bank started pursuing an easy monetary policy and there was a significant expansion of credit in the economy but the rate of inflation remained below 2.0 per cent. On the other hand, in the late 1990s, monetary policy was made more restrictive, but the inflation rate continued to remain high. Again, the Bangladesh Bank has been pursuing tight monetary policy since March 2005 to check the inflationary pressure -- Cash Reserve Requirement (CRR) was raised and commercial banks were asked to raise their lending rates -- but the general price level continued to rise. Instead of containing inflation, the curtailment of private sector credit by commercial banks has been adversely affecting investment and productive activity in the economy."
"In support of the Bangladesh Bank's tight credit, high interest rate policy, the example of India is often cited. It is pointed out that in India, restrictive monetary policy significantly brought down the inflation rate in the recent months. However, what is not mentioned is that easy access to bank credit has in fact been the key to India's robust -- 8.5-9.0 per cent -- GDP growth in the recent years."
It noted: "A significant contributor to the rising inflation rate in the country is the high government borrowing from the banking system to meet its non development expenditure, and yet Bangladesh Bank's monetary policy is designed mainly to curb private sector credit growth, the consequence of which will be to restrain private investment, reduce production in the real sectors, and thwart employment generation in the country where 40 per cent of the economically active population are unemployed or under-employed."
"Bangladesh Bank records show that the growth of private sector credit in FY07 decelerated to 15.6 per cent from 17.1 per cent in FY06, but net credit to the government and public sector since FY05 has increased at rates at least twice faster than private sector credit growth. In the current fiscal, credit to government will increase much more to enable it meet the large budget deficit of Tk. 255.81 billion (5.6 per cent of GDP), some 75.35 per cent of which will be financed through domestic borrowing."
According to the Chamber, a reduction of the government's domestic borrowing to defray its non-development expenditure will have a significant lasting impact on the overall inflationary pressure.
"Two mechanisms through which the budget deficit affects the general price level are the displacement of investible funds and monetary expansion. The deficit financed by borrowed resources displaces or crowds out the private sector demand for credit. Given the low productivity of investment in the public sector and/or borrowed money sometimes used to finance current expenditure, this displacement essentially retards production of goods and services, which would have been otherwise possible if the credit was made available to the private sector.
"There is a growing realisation among producers and consumers that government expenditures result in a higher level of prices because those are largely unproductive expenditures that do not contribute to the accumulation of profits. As we first learnt from Adam Smith, profits are the source of new capital investment, which, in turn, determines an economy's rate of growth. While it is true that government spending programmes can at times provide the economy with a temporary stimulus (e.g., hiring unemployed workers in public work projects), over the long run these activities do not add to national wealth", it added.
The Metropolitan Chamber of Commerce & Industry (MCCI) has called upon the government to urgently review and relax the monetary policy and reduce its own borrowings from the banking sector.
"The key to price stability lies in greater productivity from investments in plant, property, equipment and people. This can occur only in a regime of lower short and long term interest rates", according to the MCCI, the country's leading chamber body.
In an editorial comment in its latest monthly -- Chamber News -- the MCCI said: "Despite sincere efforts by the government to contain the price spiral through various administrative and budgetary measures, the same continues to rise unabated.
"According to BBS data, the overall inflation rate on point-to-point basis in July 2007 stood at a 10-year high of 10.20 per cent. In June it was 9.20 per cent. Food inflation on point-to-point basis was 11.0 per cent in July, which was 9.82 per cent in June. Inflation of non-food items in July was 10.0 per cent, which was 9.34 per cent in June", it added.
It noted: "Higher domestic and international prices of essential products like food and fuels, depreciation of the Taka, increase in the administered prices of petroleum products by 21-33 per cent in April last to bring them closer to world prices, and the lack of proper supply management have contributed to the price spiral.
"We appreciate the Government's efforts to ease down the prices of the essential products by such means as monitoring markets, opening wholesale centres and retail outlets, and reducing import duties on certain products, but these ad hoc measures are essentially temporary and cannot be expected to cater to the demands of a wider population and reduce price pressure unless the supply situation can be improved through imports and increased domestic production.
Inflation in Bangladesh, it said, has been predominantly of a cost-push variety, which discourages production. A solution of this problem will require not just the pure monetary theory approach, but a strategy for removal of supply bottlenecks and increased production and productivity in all productive sectors of the economy.
It observed: "Milton Friedman's argument that inflation is essentially a monetary phenomenon has proved to be incorrect in many countries, including in his own, the United States."
In its commentary, the MCCI recalled the situation in the United States during the 1970s and 1980s while pointing out that the supply-side economic policies of the Reagan-Bush era (1980-1992) were successful in stopping the persistent inflation and stabilising prices. "Lower interest rates were brought about to permanently wring inflation out of the economy".
It said: "The resurgence in American manufacturing was largely due to cheaper long-term financing for new plants and equipments. Consumers and workers also benefited greatly from the low-interest policy. The decline in interest rates on consumer loans to finance purchases of automobiles and consumer durables was a key factor in maintaining overall economic growth. A stable price environment that resulted from the Federal Reserve's easy money policy allowed both lenders and borrowers to engage in profitable transactions that facilitated consumption and increased the pool of private investment capital. Bangladesh policy makers can derive lessons from this example."
It further said: "Historical experience of many other countries, too, shows that monetary approach practised by them generated significant economic costs -- slow growth, falling investment, job losses, and high real interest rates. The adoption of tight monetary policy focusing on lowering the rate of inflation, with little regard to its impact on "real variables" such as employment, investment and growth, cannot, therefore, be appropriate.
"Empirical research has not found any correspondence between changes in money supply and the rate of inflation in Bangladesh. In the late 1980s, the Bangladesh Bank started pursuing an easy monetary policy and there was a significant expansion of credit in the economy but the rate of inflation remained below 2.0 per cent. On the other hand, in the late 1990s, monetary policy was made more restrictive, but the inflation rate continued to remain high. Again, the Bangladesh Bank has been pursuing tight monetary policy since March 2005 to check the inflationary pressure -- Cash Reserve Requirement (CRR) was raised and commercial banks were asked to raise their lending rates -- but the general price level continued to rise. Instead of containing inflation, the curtailment of private sector credit by commercial banks has been adversely affecting investment and productive activity in the economy."
"In support of the Bangladesh Bank's tight credit, high interest rate policy, the example of India is often cited. It is pointed out that in India, restrictive monetary policy significantly brought down the inflation rate in the recent months. However, what is not mentioned is that easy access to bank credit has in fact been the key to India's robust -- 8.5-9.0 per cent -- GDP growth in the recent years."
It noted: "A significant contributor to the rising inflation rate in the country is the high government borrowing from the banking system to meet its non development expenditure, and yet Bangladesh Bank's monetary policy is designed mainly to curb private sector credit growth, the consequence of which will be to restrain private investment, reduce production in the real sectors, and thwart employment generation in the country where 40 per cent of the economically active population are unemployed or under-employed."
"Bangladesh Bank records show that the growth of private sector credit in FY07 decelerated to 15.6 per cent from 17.1 per cent in FY06, but net credit to the government and public sector since FY05 has increased at rates at least twice faster than private sector credit growth. In the current fiscal, credit to government will increase much more to enable it meet the large budget deficit of Tk. 255.81 billion (5.6 per cent of GDP), some 75.35 per cent of which will be financed through domestic borrowing."
According to the Chamber, a reduction of the government's domestic borrowing to defray its non-development expenditure will have a significant lasting impact on the overall inflationary pressure.
"Two mechanisms through which the budget deficit affects the general price level are the displacement of investible funds and monetary expansion. The deficit financed by borrowed resources displaces or crowds out the private sector demand for credit. Given the low productivity of investment in the public sector and/or borrowed money sometimes used to finance current expenditure, this displacement essentially retards production of goods and services, which would have been otherwise possible if the credit was made available to the private sector.
"There is a growing realisation among producers and consumers that government expenditures result in a higher level of prices because those are largely unproductive expenditures that do not contribute to the accumulation of profits. As we first learnt from Adam Smith, profits are the source of new capital investment, which, in turn, determines an economy's rate of growth. While it is true that government spending programmes can at times provide the economy with a temporary stimulus (e.g., hiring unemployed workers in public work projects), over the long run these activities do not add to national wealth", it added.