Monetary Policy: Flirting with inflation

Monetary Policy has the unenviable and often daunting task of simultaneously promoting or sustaining growth in gross domestic product (GDP) and containing inflation within reasonable bounds. The task set for monetary policy is daunting because, as it is known to many, growth and inflation are often at loggerheads and work at cross-purposes. Unless the growth process leads to immediate increase in the supply of goods and services, inflationary tendency can take a firm hold sending prices of consumer goods and inputs for industrial production higher. This not only increases cost of living of individuals but at the same time spike the cost of production for producer of goods. Both have a negative impact on investment, the first by reducing consumer demand and the second, through higher interest rates for money borrowed from banks.
Movement of inflationary trend depends on types of investment made. Investments in manufacturing or in agriculture sector increase supply of consumer goods and industrial raw materials or intermediate inputs all of which help keep price levels of the products of these sectors stable within a short time lag i.e. between investment and production. But if investment is on non-productive goods like production of machinery or industrial inputs, the time lag is stretched; going from short to medium term, the prices of consumer goods is pushed higher by increasing the supply of broad money in the economy. When investment is in infrastructure, the inflationary pressure on prices of consumer goods tends to send them higher because such investments do not add to production of consumer goods and services even in the medium term. The construction of roads, highways, bridges, ports, development of economic zones and investment in energy sector for power generation do not result in immediate increase in supply of goods and services. Their contribution to production of goods and services is indirect and the time lag between investment and reflection on production stretches from medium to long term, depending on the scale of investment. Unless agriculture and manufacturing sector are already robust, the supply chain of goods in these sectors are not augmented in the short term when investment takes place in various infrastructures. For example, investment in a new power plant has a gestation period of several years as has major irrigation projects like a barrage. It is, therefore, a fail-safe situation when production is thwarted because of inadequate infrastructure and inflationary pressure becomes untamable resulting from 'non-productive' investment on infrastructure. The positive side in this dilemma lies on the qualifier 'short term' because it holds the prospect of a turnaround in production of goods and services in the medium term once the travail in the form of shortage in supply in the short term is weathered.
Inflationary tendency also depends on whether investment is made through public or private sector. By and large, investment in private sector is made in manufacturing or in value-addition type of activities like agriculture, agro-based industries and medium-scale enterprises including garment factories. Excepting energy, where private sector in Bangladesh has become increasingly involved, private sector investments have been mostly in productive sectors which have a non-inflationary impact on the economy. By contrast, investment in public sector being mostly on infrastructure, are non-productive in the short term and as such has a built-in tendency to stoke inflation. It, however, does not follow from this that such investments can be avoided or delayed. Infrastructure network underpin the productive activities in the economy and as such is crucial in accelerating growth across the sectors in the economy. The question is not whether to have investment in infrastructure but what is the most effective and less inflationary strategy for the same.
The above discussion is familiar to many but bears repetition because it is relevant while analysing a monetary policy that has promotion of economic growth as measured by gross domestic product (GDP) and containing inflation as its goals. With this in mind, the monetary policy statement (MPS) for the second half (H2) of the fiscal 2018-2019 can be analysed to see how far it is supportive of growth and promises to be successful in controlling inflation.
The monetary policy for the second half (H2) of the present fiscal aims at helping to achieve 7.8 per cent growth of GDP, as the goal has been fixed for the economy in the budget, and keeping inflation within reasonable limits. These goals of the MPS for the H2 became clear when the chief of the central bank of Bangladesh declared while announcing the MPS: 'we are supporting the growth target while guarding inflation to remain below the permissible limit'.
As in the past years, GDP growth will take place through investment in public and private sectors which have a trend record of investing below 30 per cent of GDP. Time and again, it has been pointed out that the investment-GDP ratio has to be raised from the current level of 26 and 28 per cent for the private and public sector respectively. The monetary policy for H2 is not explicit about its present and possible contribution to investment and measures for raising the investment level in the private sector. By bringing down the target for private sector credit growth to 16.5 per cent during H2 from 16.8 per cent in H1 signal has been sent for the present that the private sector is not expected to increase the investment level from the current one. On the other hand, by raising the public sector credit growth to 10.9 per cent during H2 compared to 8.5 per cent in H1 indicates that a greater role is envisaged for the public sector in investment. This is major shift in policy stance as regards the strategy of growth. Even if it is a temporary one, this strategy has important implications for growth and inflation. The preponderance of major infrastructure projects has perhaps already made this strategy a fait accompli. If the mega projects of infrastructure are financed through concessionary aid with long repayment period and nominal interest, it will have no or very little impact on inflationary situation. But when financed through suppliers credit with not-so-generous interest rate and a short repayment period, mega projects can fuel inflation. Borrowing from banks to finance these projects at increasing rate, as is indicated by the higher target for public sector credit growth in the MPS of H2, can only exacerbate the inflationary situation. As has been revealed in the MPS, the core inflation increased to 4.65 per cent on annual average basis in December last from 3.59 per cent in January 2018. It was 3.94 per cent in July 2018. The economy is evidently heating up but the MPS, though aware of this, has not expressed any concern or taken any measure.
The mode of financing the mega projects through suppliers credit and bank borrowing and the scaling down of private sector investment as indicated by the decrease of the target of credit growth for the sector imply that incipient inflation, which is on the rise, may threaten to break out of the “permissible limit”. This is also likely because of the greater multiplier effect of expenditure in the public sector compared to private sector. It seems the financing of infrastructure projects has been made a responsibility of monetary policy rather than that of fiscal instruments. If mega projects and other infrastructure projects are financed mostly out of revenue earned by the government, there will be no or very little pressure on banks for provision of credit to the public sector. Nor there would be much reliance on suppliers credit. Infrastructure development in these scenarios would not contribute to inflation beyond the safe limit. But this may not be the case, at least for the near future. The change in policy stance as indicated by the MPS for H2 in respect of the public and private sector credit growth, therefore, is a cause for concern.

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