Same policy, different outcomes

There is little doubt that Sheikh Hasina and her government have done harm to the national economy by recklessly borrowing money from overseas to invest in low productivity projects. She had increased the national external debt more than five-fold during her reign (from about US$20 billion to $104 billion). Much of this money was siphoned off to overseas destinations and the nation was burdened with hefty debt servicing liabilities. Thus, in just about 12 years she had turned a balance of payments-safe country to near bankruptcy. Toward the end of her reign, she was urgently seeking international lenders to borrow more money from but failed to attract funds. Her desperate rush to India in June 2024 did not result in a promise of funds, nor did the visit to China in July yield a positive outcome, except for a paltry handout.
Ironically, the interim government is now forced to desperately seek donors or lenders to borrow funds from in order to pay off foreign creditors and build up the stock of international reserves to a safe amount. During his recent visit to the United Nations (UN) head quarters in New York, Dr Yunus has secured the assurances of funds from multilateral institutions amounting to over US$10 billion. It is also likely that more funds will be given by others. This suggests that a credible client may attract funds even when the country is in a bad shape. Hasina had turned Bangladesh government into a risky debtor. Hence, no credit institution was keen to do business with it.
However, these loans, while providing some support to the reserves, will also add to the stock of international debt owed by Bangladesh and also to the debt servicing liabilities which are already onerous. Thus, these loans provide only a temporary respite to allow time to reset the economy to a trajectory that would ensure adequate surplus to pay off the loans in time. v There is a concern now that the nation has plunged into an economic crisis. Rising inflation, sharply falling international reserves, external as well as domestic debt explosion, large currency depreciation, falling growth rate of the economy, gaping current account deficits, large-scale capital flight and chaos in the banking sector, all seem to intensify the anxiety of a crisis.
However, treating these problems separately does not help policy making. The government has essentially only two policies: monetary policy executed by the central bank and fiscal policy executed by the Ministry of Finance. In many countries of the world, especially the West, it has become a norm to employ monetary policy to control inflation, while fiscal policy is deployed to influence economic growth or employment.
In some of my earlier papers (in the Financial Express) I have tried to explain that most of the above-mentioned economic problems, can be said to have been caused mainly by excess demand, that is, spending over and above our income. The national accounts of Bangladesh corroborate that the country had suffered from excess demand for many of the past years. The greater the excess demand, the worse would be some or all of the problems mentioned earlier. Hence, the intensity of these problems can be reduced only by reducing the excess demand.
The government can reduce excess demand by adopting a tight monetary policy or a tight fiscal policy. Both were suggested by IMF in its January 2023 loan agreement with Bangladesh. A tight monetary policy refers to reducing liquidity or raising the interest rate. Bangladesh Bank has already clamped down on liquidity and raised the policy rate very substantially. The noise made by the banking sector suggests that the liquidity crunch is being felt. This should have some dampening effect on spending, and hence inflation, unless offset by other contradictory policies.
Bangladesh Bank had undertaken a tight monetary policy as a condition for a bail-out package of IMF last year. Both the former governor who negotiated the package and the current governor (who is an ex-IMF staff) followed this same monetary policy since then. The former governor could not show any improvement of the economy in more than a year and half, on the contrary the expectations about the economy worsened under his watch. But the current governor seems to have already made some positive impact on the banking sector. There are expectations of an improvement in the economic conditions, too. An interesting question is how the essentially same policy could have such different outcomes.
To seek an answer to this paradox, recall that excess spending (demand) is the principal cause of our problems. Excess spending is a major contributor to inflation. It is directly related to the current account deficit, which drains the international reserves or increases the external debt or both. This leads to a depreciation of the domestic currency, which also contributes to inflation. This should have been known to the former government economists, or at least the Bangladesh Bank economists. The fact that they acquiesced to measures that pulled the economy into a crisis suggests that they had other priorities.
No one needs convincing that the topmost priority of Sheikh Hasina was to perpetuate her rule just like the ambition of her father. She was willing to do anything including compromising sovereignty, looting banks and killing of thousands of people just to protect her reign. To survive in power, she needed the active support of the civil and military bureaucracy, the business sector as well as her party members and supporters since she did not have much to offer to the general public. Hence, she went about creating an 'aristocracy'of mostly loyal officers, oligarchs and enthusiastic party loyalists, while condemning the rest to serfdom. To ensure her political survivability she did away with free, fair and inclusive elections to ensure the exclusion of all probable serious contestants in elections not approved by her. To ensure there will be no public uprising against her in the long term, she undermined the education system (i.e. human capital) such that it produced only fatalists and zombies who would not be able to anticipate where the country was heading to. To weed out any remaining troublemakers who escaped the net, she replicated the tactics of Mossad or its regional versionto individually destroy them.
All such acts require tremendous amount of resources besides attractive government or party positions. Fiscal instruments and raw government power became the obvious choices for raising funds. All in civil and military positions of power were given the green light to use that power to collect incredible amounts of money and other benefits. The crème de la crème of this structure was Hasina herself, her family members and relatives, important civil and military and bureaucrats, powerful party members and oligarchs. A convenient way of obtaining funds was government contracts, such as the construction of infrastructure. Among the infrastructure projects the most sought after were the ones financed by foreign borrowing which ensured investment without saving and bribes could be paid in their accounts in foreign banks in international reserve currencies. The favoured oligarchs were chosen for the construction of the larger projects for a consideration.
She extorted money from banks. Most extraordinarily, she expelled the legally constituted boards of directors of several banks and financial companies, and replaced them with her trusted loyalists. To provide a political cover to this thinly veiled government-led banking coup, she chose the Islamic banks and companies. These have now piled up enormous amount of non-performing loans with little chance of recovery as the funds obtained from these loans have been mostly transferred overseas to keep them out of the reach of any future government.
A government such as Hasina's cannot possibly reduce budget spending, rather it is compelled to increase it to ensure the stability of its support base. The budget spending of the Hasina government increased seven-fold between 2008-09 and 2023-24, and the budget deficit increased from a modest 2.8 per cent of gross domestic product (GDP) to an unsustainable 5.2 per cent. Such a large acceleration in government spending was mainly responsible for fuelling the economic crisis that the nation is suffering from now.
The former governor was a trusted and loyal servant of the government. He had to seek funds from IMF to replenish international reserves so as to be able to pay for the essential imports and debt liabilities. This meant that he had to accept some stabilisation measures suggested by it. He reluctantly increased the policy rate and the exchange rate but much less than what were needed. More importantly, he could take precious few measures to restore the health of the banking sector since this would necessitate taking steps against other loyalists. To worsen matters the fiscal policy was not supportive of the monetary policy. No wonder that the monetary policy did not yield the stated objectives.
The new governor was not burdened with any such compulsion. So, he could promptly take the necessary measures. The policy rate and the exchange rate were both increased substantially to stabilise the market. The most important step was the prompt termination of the boards of directors of the hijacked banks and replacing them with the original directors including the managing directors. To anchor expectations, he announced his policy intentions. These measures channelled expectations in the desired direction which helped to reduce the instability of the market.
The most important message of the foregoing is that the success of monetary policy depends as much on the government's other policies and action as it does on the monetary policy itself. The positive impact of a tight monetary policy can be easily swamped by an extravagant fiscal policy as well as the erosion of the economic and social infrastructure of the country. Hence, policy effectiveness should be judged in a holistic manner.

The author is a professor of economics at Independent University, Bangladesh.
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