The rising trend of inflation
Sunday, 29 July 2007
Shahiduzzaman Khan
IMPACT of rising inflation is being felt almost everywhere. The prices of essential commodities have gone up and so the cost of living in Bangladesh. Country's vast multitude of the poor and the unemployed people are having a difficult time to survive.
Slowly but steadily the situation is aggravating. According to unofficial sources, inflation has already hit 7.0 per cent-- a figure much higher than the neighbouring countries. In the country, it had never gone beyond 5.0 per cent during the last two decades.
The government, in an attempt to arrest rising trend of inflation, decided to bring down the growth rate of broad money to 15 per cent from the existing 19.21 per cent aiming to contain inflation below 7.0 per cent. It will also mop up excess liquidity from the banking channel.
Country's leading economists, however, opposed the government decision to adopt a contractionary monetary policy to check inflation and credit growth. They said this is part of the IMF's 'traditional set of common prescription' that does not take into account the socio-economic reality. If the government gives in to IMF pressure, they fear, development will be destabilised and inflation will not be contained in the long run.
Inflationary trend will aggravate if there are increases in service charges, gas and power tariff and utility prices to generate more non-tax revenue. The projected cutting of development expenditure would lead to a reduction in social sector expansion, which will ultimately hinder the poverty programmes.
The economists expressed their views that the engine of private sector growth would not rebound unless the government machinery ensures good governance, curbs corruption and checks misuse of public funds. They are concerned as to how the government is going to strike a balance between the two conflicting policies -- an inflated public spending and restricting money supply to private sector.
They are also not convinced that rates hike will eventually help rein in inflation. They believe a tightened monetary policy is unwelcome when the economy has shown signs of near stagflation with slower growth, high inflation and high unemployment. A contractionary policy, they fear, will only result in an adverse impact on investment, employment generation and economic growth. Some of them expect the measures to be stopgap and backed by precautionary measures to make sure that investment in productive sectors is not discouraged.
Country's leading businessmen also opposed the idea. They said the country's economy has already started getting the benefits of the lower interest rate regime. Production costs came down improving the international competitiveness. Quantum Index of Production (QIP) has increased by 2.0 percentage points recently indicating creation of new job opportunities. Businesses claimed there are also indicators to show reduction of poverty. High cost of credit will negate the on-going growth process.
In Bangladesh, interest rates are in the 12-15 per cent range as against 6.0-7.0 per cent in India, 5.0 per cent in Pakistan, and as low as 2.7 per cent in Sri Lanka. On export credit, too, the interest rate is much higher in Bangladesh -- around 7.0-10 per cent -- which is more than twice the rate prevailing in India and Pakistan.
Inflation in this country has never been a monetary phenomenon alone. For instance, in the second half of the 1990s, monetary policy was made more restrictive, but inflation rate continued to remain high. On the other hand, monetary policy was eased starting from 1989, when the inflation rate declined to below 2.0 per cent despite significant expansion of credit in the economy.
Major factors that contributed to price increases are decline in productivity, budget deficits, supply shocks, production losses, frequent increases in the prices of fuel oil, power and gas, devaluation of the currency, and problems of law and order. Poor law and order conditions are seen as a significant factor behind price rises. Businessmen have frequently complained that extortion by different groups of miscreants at all stages of production, transportation, wholesale marketing and retailing raises the prices of essentials.
Against this backdrop, much depends on decisions which have more to do with law and order problems, fiscal and trade policy, exchange rate management, infrastructural bottlenecks, administered prices, and monetary policy in order to contain inflation. Raising interest rates without addressing such problems will aggravate rather than control any inflationary pressure.
Meanwhile, the government is also under heavy pressure to raise the gas, power and petroleum prices by the IMF and the World Bank. There have been recent hikes in prices of gas and petroleum. But the development partners are pressing the government to increase more. The government is contemplating reviewing gas and fertiliser prices again this year. Thus the rise in gas, power and oil prices will add to the inflationary trend as transportation, power generation and distribution cost will go up substantially.
Many economists think that squeezing the credit flow and venturing on a lofty expenditure ahead of the general election will be 'the worst of the worse'. Such policy inconsistency will retard economic growth and investment. The central bank pursues the contractionary policy to contain inflation, but it is unlikely to come down since the government has announced an ambitious annual development programme, they opined.
While the poor quality of public investment will hardly bolster the growth rate, the IMF-dictated policy that crowds out private investment, will have a negative impact. Instead of applying brakes on private investment, which peaked on the back of a lower rate regime, the central bank should restrict import of consumer goods through alternative measures like imposing higher margins on import letters of credit. Obviously inflation is a major concern, but it has not gone as high as to impose restriction on investment.
A number of monetary experts fear that tightening of the money supply will retard growth in business and investment in a situation where entrepreneurs are less inclined to invest. It may contain inflation to some extent but will prove futile in the long run as the present inflationary trend is not caused by money supply. The government should go for 'planned expansion' not only for the approaching general elections but also for a normal course so that business and investment can grow smoothly. There should be expansion, but it must not go uncontrolled, unregulated.
While taking steps to restrict spending on luxury and consumer imports, the government must make sure that import of capital machinery and raw materials used in export-oriented industries are not affected in any way. A mechanism must be there to monitor that imports of capital machinery and industrial raw materials are not hindered due to restriction on import payment and tightening of foreign currency outflow. Stock market analysts feel that the high interest rate regime will hold back the upward trend in the capital market seen since 2004. Liquidity crunch led to volatility in the money market early this year and the capital market saw many institutional players pull out money out of the market.
The government, however, needs to take appropriate fiscal and prudent policies that encourage higher capacity utilisation, more investment, etc., to bring about a downward slide of prices and thereby ckeck inflationary trend.
IMPACT of rising inflation is being felt almost everywhere. The prices of essential commodities have gone up and so the cost of living in Bangladesh. Country's vast multitude of the poor and the unemployed people are having a difficult time to survive.
Slowly but steadily the situation is aggravating. According to unofficial sources, inflation has already hit 7.0 per cent-- a figure much higher than the neighbouring countries. In the country, it had never gone beyond 5.0 per cent during the last two decades.
The government, in an attempt to arrest rising trend of inflation, decided to bring down the growth rate of broad money to 15 per cent from the existing 19.21 per cent aiming to contain inflation below 7.0 per cent. It will also mop up excess liquidity from the banking channel.
Country's leading economists, however, opposed the government decision to adopt a contractionary monetary policy to check inflation and credit growth. They said this is part of the IMF's 'traditional set of common prescription' that does not take into account the socio-economic reality. If the government gives in to IMF pressure, they fear, development will be destabilised and inflation will not be contained in the long run.
Inflationary trend will aggravate if there are increases in service charges, gas and power tariff and utility prices to generate more non-tax revenue. The projected cutting of development expenditure would lead to a reduction in social sector expansion, which will ultimately hinder the poverty programmes.
The economists expressed their views that the engine of private sector growth would not rebound unless the government machinery ensures good governance, curbs corruption and checks misuse of public funds. They are concerned as to how the government is going to strike a balance between the two conflicting policies -- an inflated public spending and restricting money supply to private sector.
They are also not convinced that rates hike will eventually help rein in inflation. They believe a tightened monetary policy is unwelcome when the economy has shown signs of near stagflation with slower growth, high inflation and high unemployment. A contractionary policy, they fear, will only result in an adverse impact on investment, employment generation and economic growth. Some of them expect the measures to be stopgap and backed by precautionary measures to make sure that investment in productive sectors is not discouraged.
Country's leading businessmen also opposed the idea. They said the country's economy has already started getting the benefits of the lower interest rate regime. Production costs came down improving the international competitiveness. Quantum Index of Production (QIP) has increased by 2.0 percentage points recently indicating creation of new job opportunities. Businesses claimed there are also indicators to show reduction of poverty. High cost of credit will negate the on-going growth process.
In Bangladesh, interest rates are in the 12-15 per cent range as against 6.0-7.0 per cent in India, 5.0 per cent in Pakistan, and as low as 2.7 per cent in Sri Lanka. On export credit, too, the interest rate is much higher in Bangladesh -- around 7.0-10 per cent -- which is more than twice the rate prevailing in India and Pakistan.
Inflation in this country has never been a monetary phenomenon alone. For instance, in the second half of the 1990s, monetary policy was made more restrictive, but inflation rate continued to remain high. On the other hand, monetary policy was eased starting from 1989, when the inflation rate declined to below 2.0 per cent despite significant expansion of credit in the economy.
Major factors that contributed to price increases are decline in productivity, budget deficits, supply shocks, production losses, frequent increases in the prices of fuel oil, power and gas, devaluation of the currency, and problems of law and order. Poor law and order conditions are seen as a significant factor behind price rises. Businessmen have frequently complained that extortion by different groups of miscreants at all stages of production, transportation, wholesale marketing and retailing raises the prices of essentials.
Against this backdrop, much depends on decisions which have more to do with law and order problems, fiscal and trade policy, exchange rate management, infrastructural bottlenecks, administered prices, and monetary policy in order to contain inflation. Raising interest rates without addressing such problems will aggravate rather than control any inflationary pressure.
Meanwhile, the government is also under heavy pressure to raise the gas, power and petroleum prices by the IMF and the World Bank. There have been recent hikes in prices of gas and petroleum. But the development partners are pressing the government to increase more. The government is contemplating reviewing gas and fertiliser prices again this year. Thus the rise in gas, power and oil prices will add to the inflationary trend as transportation, power generation and distribution cost will go up substantially.
Many economists think that squeezing the credit flow and venturing on a lofty expenditure ahead of the general election will be 'the worst of the worse'. Such policy inconsistency will retard economic growth and investment. The central bank pursues the contractionary policy to contain inflation, but it is unlikely to come down since the government has announced an ambitious annual development programme, they opined.
While the poor quality of public investment will hardly bolster the growth rate, the IMF-dictated policy that crowds out private investment, will have a negative impact. Instead of applying brakes on private investment, which peaked on the back of a lower rate regime, the central bank should restrict import of consumer goods through alternative measures like imposing higher margins on import letters of credit. Obviously inflation is a major concern, but it has not gone as high as to impose restriction on investment.
A number of monetary experts fear that tightening of the money supply will retard growth in business and investment in a situation where entrepreneurs are less inclined to invest. It may contain inflation to some extent but will prove futile in the long run as the present inflationary trend is not caused by money supply. The government should go for 'planned expansion' not only for the approaching general elections but also for a normal course so that business and investment can grow smoothly. There should be expansion, but it must not go uncontrolled, unregulated.
While taking steps to restrict spending on luxury and consumer imports, the government must make sure that import of capital machinery and raw materials used in export-oriented industries are not affected in any way. A mechanism must be there to monitor that imports of capital machinery and industrial raw materials are not hindered due to restriction on import payment and tightening of foreign currency outflow. Stock market analysts feel that the high interest rate regime will hold back the upward trend in the capital market seen since 2004. Liquidity crunch led to volatility in the money market early this year and the capital market saw many institutional players pull out money out of the market.
The government, however, needs to take appropriate fiscal and prudent policies that encourage higher capacity utilisation, more investment, etc., to bring about a downward slide of prices and thereby ckeck inflationary trend.