Policy options in a crisis economy
Friday, 4 January 2008
MA Taslim
BANGLADESH has been buffeted by a series of extraneous shocks during the last year or so which have created a near crisis situation in the economy. Designing correct economic policies in the current milieu is not an easy task. There is no magic wand solution to the complex problems raised by the inflationary price spiral combined with a slowing output, a situation sometimes referred to as stagflation. Much patient work will be needed to find a good policy mix.
The first thing to bear in mind is that inflation is essentially a monetary phenomenon. If money supply is squeezed sufficiently, it will ultimately bring down the prices. The problem with this facile solution is that it also brings down the growth rate, at least in the short to medium term. Income and employment decline with adverse ramifications. But if inflation is not contained it jeopardises the longer term stability and growth of the economy the cost of which may very well outweigh the short term gains. Thus a suitable balance needs to be struck.
A tightening of monetary policy to control inflation will inevitably raise the interest rates. Higher rates discourage borrowing and thereby depress investment, which in turn reduces output by a multiplier process. However, interest rates are just one of the factors determining investment. One of the most important determinants of investment is the business estimate of future profitability, which is sometimes referred to as business confidence. Due to some erroneous policy interventions in the recent past, business confidence has been severely eroded; and many businesses appear to have taken themselves out of business, at least temporarily. It is unlikely that the business community will engage in much additional investment if the interest rate is lowered one or two percentage points through an easing of the monetary policy.
The commercial banks currently hold large idle cash since there are not enough borrowers in the market. There is only a small cost in persisting with the current 'cautious' policy or even tightening it a little. If this helps to bring down the inflation rate by a few percentage points the cost is well worth incurring.
Inflation is one of the two main concerns of macroeconomic policy - the other is accelerating economic growth or employment. This requires more, and not less, investment. Since private investment is unlikely to increase, and will conceivably fall, total investment can be increased only by increasing public investment. Hence, to give a boost to economic activities the government should consider a policy mix of 'cautious' monetary policy with an expansionary fiscal policy for a year or so. This will increase the aggregate demand of the economy, which will exert an upward pressure on prices. But with a tighter monetary policy and high quality public investment that raises productivity it should be possible to contain the prices. The government must also ensure adequate supply of essential goods through imports or otherwise to prevent their prices from rising, otherwise the policy mix will fail to attract public support.
People do not complain much about inflation if their money incomes also increase in tandem, i.e. if real incomes are protected. What has made the current bout of inflation particularly unbearable is the simultaneous fall in income of a large section of the population at the lower end of the income scale due mostly to some recent government actions. An expansionary fiscal policy may go some way in restoring incomes provided it is designed in a manner such that the impact benefits the poor. The government should also take measures to encourage greater flows of remittances which augment household income and help stabilise the exchange rate.
Special attention will have to be given to agriculture to ensure that it quickly rebounds from the adverse effects of the floods and cyclone. Agricultural inputs, especially seed, fertilizers and diesel, must be made available to farmers promptly. The current impasse with fertilizer marketing must be resolved expeditiously. Provisions should be made for adequate credit, if necessary at subsidised rates, to ensure that the farmers have access to the agricultural inputs. The government cannot take chances with agriculture during the next year; it has to do all it can to ensure good crops if a food crisis is to be avoided. All the good work done so far will come to naught if such a crisis develops.
The government could direct increased fiscal spending to flood and cyclone rehabilitation in the first instance. Schemes should be drawn up quickly to repair damaged roads and bridges. Flood and cyclone affected people should be provided with the wherewithal to rebuild their lives. Rural haats, bazaars, schools and hospitals should be given resources to repair and improve their infrastructures. Interest subsidies could be provided to flood-damaged rural industries, including fishery and poultry, to help them recover. New infrastructure projects in the energy, power and communication sectors should be commenced. (This is not meant to be an exhaustive list, but rather suggestive.)
Such an expansionary program will raise the tempo of economic activities, expand employment and raise income of the poor people (and some rich ones, too). This will also open up many private business opportunities and help toward restoring business confidence. The government must also take appropriate measures to improve the private investment climate. When there are signs of private business picking up, the government could roll back fiscal spending.
Although all efforts should be made to mobilise domestic resources, it is unlikely to be hugely successful in the short term. Hence, to fund such an expansionary program the government will have to borrow. It should refrain from borrowing from the Bangladesh Bank because of its inflationary consequences. Since the commercial banks have large stocks of excess reserves, the government could borrow from them without crowding out private investment. Commercial bank profitability will increase as a result of such borrowing helping their balance sheets. It could also borrow from development loan agencies on concessionary terms if available.
Increased borrowing will obviously raise public debt and hence, future debt service payments. However, Bangladesh has a comfortable debt situation; its debt ratio is the lowest in the region. It can increase the debt ratio by a few percentage points without much adverse consequence if it helps to raise the economic growth rate. If the expansionary program succeeds, economic growth will pick up and business confidence should improve. This will permit a roll back of the program within a year or two. The higher national income should raise total government revenue if the revenue collection effort is not relaxed. With higher revenue and lower expenditure in the future the government will have the resources to pay off the incremental debt such that the budget balance will not be unduly stressed in the future.
It might be possible to reduce the necessity of higher fiscal spending if significant foreign investment could be attracted. Some of the infrastructure projects, especially in the energy, power and communication sectors, could be opened up for foreign investment.
Investment proposals already on offer should be properly evaluated and final decisions made. Regulatory reforms that are needed to attract foreign investment must be designed and implemented expeditiously. Higher foreign investment is also likely to act as a catalytic agent to spur greater domestic investment.
The principal problem with an expansionary fiscal program is that success depends on the capacity of the government. The past record of the government in designing and implementing development budgets is not very encouraging. However, considering the grave challenge the nation is now facing, the government must rise to the occasion.
It should mobilise all the resources at its command to deal with the economic crisis on hand. If it fails to accelerate growth the nation could be engulfed in a socio-political turmoil that will make the task of essential reforms that much harder to achieve.
The author is a professor of economics at Dhaka University
bdnews24.com
BANGLADESH has been buffeted by a series of extraneous shocks during the last year or so which have created a near crisis situation in the economy. Designing correct economic policies in the current milieu is not an easy task. There is no magic wand solution to the complex problems raised by the inflationary price spiral combined with a slowing output, a situation sometimes referred to as stagflation. Much patient work will be needed to find a good policy mix.
The first thing to bear in mind is that inflation is essentially a monetary phenomenon. If money supply is squeezed sufficiently, it will ultimately bring down the prices. The problem with this facile solution is that it also brings down the growth rate, at least in the short to medium term. Income and employment decline with adverse ramifications. But if inflation is not contained it jeopardises the longer term stability and growth of the economy the cost of which may very well outweigh the short term gains. Thus a suitable balance needs to be struck.
A tightening of monetary policy to control inflation will inevitably raise the interest rates. Higher rates discourage borrowing and thereby depress investment, which in turn reduces output by a multiplier process. However, interest rates are just one of the factors determining investment. One of the most important determinants of investment is the business estimate of future profitability, which is sometimes referred to as business confidence. Due to some erroneous policy interventions in the recent past, business confidence has been severely eroded; and many businesses appear to have taken themselves out of business, at least temporarily. It is unlikely that the business community will engage in much additional investment if the interest rate is lowered one or two percentage points through an easing of the monetary policy.
The commercial banks currently hold large idle cash since there are not enough borrowers in the market. There is only a small cost in persisting with the current 'cautious' policy or even tightening it a little. If this helps to bring down the inflation rate by a few percentage points the cost is well worth incurring.
Inflation is one of the two main concerns of macroeconomic policy - the other is accelerating economic growth or employment. This requires more, and not less, investment. Since private investment is unlikely to increase, and will conceivably fall, total investment can be increased only by increasing public investment. Hence, to give a boost to economic activities the government should consider a policy mix of 'cautious' monetary policy with an expansionary fiscal policy for a year or so. This will increase the aggregate demand of the economy, which will exert an upward pressure on prices. But with a tighter monetary policy and high quality public investment that raises productivity it should be possible to contain the prices. The government must also ensure adequate supply of essential goods through imports or otherwise to prevent their prices from rising, otherwise the policy mix will fail to attract public support.
People do not complain much about inflation if their money incomes also increase in tandem, i.e. if real incomes are protected. What has made the current bout of inflation particularly unbearable is the simultaneous fall in income of a large section of the population at the lower end of the income scale due mostly to some recent government actions. An expansionary fiscal policy may go some way in restoring incomes provided it is designed in a manner such that the impact benefits the poor. The government should also take measures to encourage greater flows of remittances which augment household income and help stabilise the exchange rate.
Special attention will have to be given to agriculture to ensure that it quickly rebounds from the adverse effects of the floods and cyclone. Agricultural inputs, especially seed, fertilizers and diesel, must be made available to farmers promptly. The current impasse with fertilizer marketing must be resolved expeditiously. Provisions should be made for adequate credit, if necessary at subsidised rates, to ensure that the farmers have access to the agricultural inputs. The government cannot take chances with agriculture during the next year; it has to do all it can to ensure good crops if a food crisis is to be avoided. All the good work done so far will come to naught if such a crisis develops.
The government could direct increased fiscal spending to flood and cyclone rehabilitation in the first instance. Schemes should be drawn up quickly to repair damaged roads and bridges. Flood and cyclone affected people should be provided with the wherewithal to rebuild their lives. Rural haats, bazaars, schools and hospitals should be given resources to repair and improve their infrastructures. Interest subsidies could be provided to flood-damaged rural industries, including fishery and poultry, to help them recover. New infrastructure projects in the energy, power and communication sectors should be commenced. (This is not meant to be an exhaustive list, but rather suggestive.)
Such an expansionary program will raise the tempo of economic activities, expand employment and raise income of the poor people (and some rich ones, too). This will also open up many private business opportunities and help toward restoring business confidence. The government must also take appropriate measures to improve the private investment climate. When there are signs of private business picking up, the government could roll back fiscal spending.
Although all efforts should be made to mobilise domestic resources, it is unlikely to be hugely successful in the short term. Hence, to fund such an expansionary program the government will have to borrow. It should refrain from borrowing from the Bangladesh Bank because of its inflationary consequences. Since the commercial banks have large stocks of excess reserves, the government could borrow from them without crowding out private investment. Commercial bank profitability will increase as a result of such borrowing helping their balance sheets. It could also borrow from development loan agencies on concessionary terms if available.
Increased borrowing will obviously raise public debt and hence, future debt service payments. However, Bangladesh has a comfortable debt situation; its debt ratio is the lowest in the region. It can increase the debt ratio by a few percentage points without much adverse consequence if it helps to raise the economic growth rate. If the expansionary program succeeds, economic growth will pick up and business confidence should improve. This will permit a roll back of the program within a year or two. The higher national income should raise total government revenue if the revenue collection effort is not relaxed. With higher revenue and lower expenditure in the future the government will have the resources to pay off the incremental debt such that the budget balance will not be unduly stressed in the future.
It might be possible to reduce the necessity of higher fiscal spending if significant foreign investment could be attracted. Some of the infrastructure projects, especially in the energy, power and communication sectors, could be opened up for foreign investment.
Investment proposals already on offer should be properly evaluated and final decisions made. Regulatory reforms that are needed to attract foreign investment must be designed and implemented expeditiously. Higher foreign investment is also likely to act as a catalytic agent to spur greater domestic investment.
The principal problem with an expansionary fiscal program is that success depends on the capacity of the government. The past record of the government in designing and implementing development budgets is not very encouraging. However, considering the grave challenge the nation is now facing, the government must rise to the occasion.
It should mobilise all the resources at its command to deal with the economic crisis on hand. If it fails to accelerate growth the nation could be engulfed in a socio-political turmoil that will make the task of essential reforms that much harder to achieve.
The author is a professor of economics at Dhaka University
bdnews24.com