This fiscal year is ending. There will be a lot of discussions on the progress made in this fiscal year. Economic commentators, politicians and journalists will debate on what we achieved and what we could not achieve in FY15. At the same time, discussions will also include the prospects and problems of FY16. The government has already announced the proposed budget for FY16 which will be finalised and approved by parliament very soon. Any forward-looking discussion is always helpful for the policymakers as that helps them to take preemptive measures. A good friend does not criticise someone for making a mistake rather tries to prevent him/her from committing it. The same should be done by a good economist as well.
As a result of some policy measures and actions, the FY16 will face a number of challenges and if they are not prudently taken care of, the economy may face a macroeconomic chaos. Inflation is likely to increase, money market may become unstable resulting in a credit crunch while the savings may ironically get locked in the informal sector and the growth of the economy may stumble. However, these anticipated developments can be avoided if adequate attention is given to the problems and pre-emptive measures are taken.
Inflation can restart leaping high in the next fiscal year. The government is going to implement the new pay scale for its employees from July 2015. This pay rise will increase the purchasing power of its beneficiary households. They are about 1.1 million (11 lakh) in number which account for about 3.5 per cent of total households of the country. There is no economic reason for the augmented demand of these households to increase the inflation. But the past experience suggests that implementation of any pay rise for the government employees ultimately leads to notable increase of inflation. And that happens for non-economic reasons. This year will not be an exception as the same non-economic reasons have still remained unresolved.
The non-economic reasons pertain to arbitrary increase of price by the sellers by taking advantage of imperfect market. The government has two options to check such increase of price. One is through monitoring and regulations. The other is through increasing the supply of goods and services by itself. The government suffers from capacity deficit in both counts. Therefore, the sellers will use the implementation of the new pay scale as an opportunity to increase the price of some commodities, if not all. There is no ground so far to be optimistic that this will not happen this year.
Along with many other effects, the rise of inflation also affects the money market. Think about a person who manages to save Tk 100 and now wants to earn some income by using it in the money or capital market. There is a number options that he can consider. He can deposit the money in an interest-earning bank account, he can lend it to some other individual or organisations without any legal and formal contract, he can buy savings certificate issued by the government, or he can use that money to buy shares from the secondary market. In choosing his option, the person must take the rate of inflation into consideration as the real income is affected by it.
The government has already reduced the interest rate of savings certificate by about 2 percentage points. This has already made them unattractive and the rise in inflation will make them even more unattractive. The prospect of public borrowing from the non-bank source will become uncertain forcing the government to rely more on the borrowing from the commercial banks. The question is whether the commercial banks would be able to mobilise adequate deposits to lend to the government as well as the private sector. Given the fact that the banking sector has excess liquidity for quite some time now, one may argue that any potential threat of credit crunch is not foreseen yet.
Well, the reasons for the excess liquidity is the low growth of private and public credit in the recent years, not that banks are glutted with deposits. If the public borrowing grows as per plan outlined in the FY16 budget and private investment picks up by taking advantage of the improved infrastructure and energy, the current excess liquidity may not deem adequate to meet the augmented demand for credit. This would essentially mean that banks have to mobilise additional deposits.
Banks have to offer an interest rate which is higher than the inflation rate by a reasonable margin to collect deposits. It means as the inflation increases, the cost of mobilising deposit by commercial banks will increase as well. This will increase the lending rate and thus ultimately be transmitted to the borrower. How much a bank can increase its lending rate is not unbounded. Besides, Bangladesh Bank often imposes a ceiling on lending rates if they seem to be 'very high' to it. Currently there is no ceiling but once it was 13 per cent. All this means that it will be beyond banks' ability to increase the interest on deposits to match the increase of inflation.
It has to be noted as well that the government has taken a number of measures to reinvigorate the stock market. When the inflation rate increases but the interest on deposits cannot match that increase, people will tend to use their money in the stock market with the hope of taking advantage of the artificially created windfall gain there. At the same time, people will also use their money in the informal money market. There are thousands of informal organisations, small and large, working all over the country to seize the savings of small savers by offering different financial instruments with high rate of return. After a certain period of time these organisations cease to exist leaving the depositors helpless as they do not have any legal documents and/or ability to take any legal action. The increase of inflation, coupled with reduction in interest rate on the savings certificate by the government and commercial banks' inability to increase the interest rate on deposit beyond a certain level, more money will flow to the informal money market.
Now the most important question is what should the government do to avoid the situation where inflation will run high, banks will suffer from lack of loanable funds, government itself will struggle to collects funds through non-bank sources, and target growth will become uncertain.
First of all, nothing is certain to take place in an economy. But the government has to remain vigilant and act immediately. Whatever capacity it has for market monitoring and regulations, the government should make the optimum use of it to check inflation as much as it can. It should also keep an eye on the stock market to avoid the recurrence of what happened in FY10, when potential deposits as well as bank loans flowed in the stock market squeezing the scope for commercial lending by banks. This phenomenon eventually led to a near-credit crunch at that time.
Second, although the government has reduced the rates of proffit on savings certificate, it should remain open and prepared to further revise it. Especially, if the inflation increases so high that real rate of return from savings certificate becomes too low to attract potential buyers, the government should increase the rates of profit on them.
Third, the government needs to strengthen its regulatory capacity to formalise the informal financial institutions which are currently eating up a significant portion of rural savings. At the same time, discipline in the banking sector needs to be restored. The banking sector of Bangladesh has experienced a number of financial fraudulence in the recent years which has to some extent eroded people's confidence in them. The central bank and the government should work together to prevent recurrence of such incidents in future. The banking sector which suffers from financial irregularities and lack of people's trust cannot serve the development need of the country.
Last but not least, the government should try to use other sources to collect resources to finance its deficit. Although Middle East is the main source of remittance for Bangladesh, about one-fourth of total remittance now comes from the European and North American countries. In addition to sending remittances, Bangladeshi diaspora living in these countries accumulate large amounts of savings in destination countries. The bulk of these savings is invested in bank deposits in destination countries earning little or no interest. An innovative approach can also mobilise these savings for financing development activities in Bangladesh. One such innovative approach would be the introduction of 'Diaspora Bonds' issued by the Bangladesh government to raise capital from the diasporas as an alternative to current sources of borrowing.
The practice of the diaspora bond goes back to the early 1930s when Japan and China introduced it. The 'Resurgent India Bond' issued by India when sanctions were imposed on the country following its test of a nuclear bomb, raised close to 11 billion USD from the Indian Diaspora. Ethiopia raised capital through Diaspora Bond to finance hydro-electric power generation projects. These examples should encourage the Bangladesh government to issue diaspora bond, if needed, to avoid any chaos in the financial market of the country.
Abul Basher, PhD is Researcher at Bangladesh Institute of Development Studies (BIDS), former economist, World Bank, and former faculty, Willamette University, USA.
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