In countries like Bangladesh, two critical ingredients are important in the design of monetary policy: first, a reasonable approximation of the overall economy covering real, financial, external and other sectors characterising technology, market structure and behaviour of different actors (e.g. households, enterprises, private sector, government, etc.); and second, a normative dimension that summarises the social costs and benefits from different policy actions.
Further, most of the poor and low income households live at or near the subsistence levels. In such situations, contractionary monetary policies are particularly problematic unless redistribution measures are taken along with monetary contractions. Obviously, inequality is an important dimension in the conduct of monetary policy in Bangladesh; both because it is high and a large share of the population lives at subsistence or near-subsistence levels.
In addition, the monetary policy framework needs to critically feature the external dimension, with inherent exposure to terms-of-trade shocks, financial flows, changes in global interest rates, etc. The exchange rate regime is also a critical issue for which the balance sheet effect probably needs as much emphasis as the competitiveness effect. Moreover, Bangladesh does not have open capital accounts and hence it operates under conditions of near financial autarky--in big contrast with the standard monetary policy framework.
ECONOMY'S SECTORAL COMPOSITION: The sectoral composition of the economy also matters since Bangladesh's agriculture is still an inherently highly volatile sector, with little scope for prices to adjust to supply shocks. For the credit-constrained consumers and enterprises, especially for the small farmers and cottage, micro, small and medium enterprises (CMSMEs), financial constraints are very important and play a key role in the monetary transmission mechanism.
In recent months, price increases of many agricultural commodities have accelerated rapidly and reached exceptional levels. These increases have been mainly driven by a 'perceived' temporary imbalance between demand and supply in the market. In this context, it is important to better understand how the degree of competition in the food sector and the downstream retail markets may have affected price developments and to identify regulatory practices that may help to lessen the impact on consumers of price volatility in agricultural commodity markets. Improving the functioning of the food supply chain is particularly important in the present economic circumstances. In order to sustain the purchasing power of the poorer households, it is essential that the 'unusual' price movements in commodity markets are contained and the benefits are transmitted without delay to both consumers and the small producers.
Obviously, the sharp fluctuations in food prices at a time of great uncertainty about the present economic outlook indicate the need to improve the functioning of the food supply chains with a view to enhancing their efficiency and competitiveness. The present rapid increase in food prices has been due mainly to global as well as domestic demand and supply developments. Nevertheless, problems in the functioning of the food supply chains, in terms of competition and regulation, have played an important role as well and there is room to improve the efficiency of the food supply chains.
Food price inflation differentials are a signal that the food market remains still fragmented. This fragmentation can be due to differences in regulation on market entry and pricing and to unfair business practices.
No doubt, a consolidation is taking place throughout the food supply chain, albeit slowly. This consolidation can lead to efficiency gains and hence to lower prices. However, it can also change the bargaining powers of actors in different segments of the food supply chain and could deteriorate the competition conditions at the local level. For ensuring efficient functioning of the food supply chains, a roadmap may be adopted and implemented by the relevant authorities without delay. The roadmap should include three main elements to improve the functioning of the food supply chains. First, undertake a review of potentially unjustified regulations and enhance regulatory harmonisation to reduce market fragmentation. In particular, regulations that restrict entry, limit price competition and restrict shop opening hours should be examined taking into account the wider policy objectives of these regulations. Second, the national competition and consumer authorities should ensure a vigorous and coherent enforcement of competition and consumer protection rules. In particular, investigations should be targeted at those restrictions of competition and specific practices which are potentially 'problematic'. Finally, it is crucial to provide better information and forecasts to consumers, public authorities and market operators by strengthening monitoring mechanisms of food prices and the supply chains.
A typical food supply chain is made up of six stages: (i) sourcing of inputs and raw materials; (ii) production of commodities; (iii) processing and packaging; (iv) storage; (v) wholesale distribution; and (vi) retail redistribution to the consumers. If any one of these stages is compromised, a variety of issues will arise and the whole supply chain will be in jeopardy. For the purpose, fixing food supply chain challenges are crucial.
Overall, the measures need to address lack of traceability. Traceability or the ability to track the food product through all stages of the supply chain is necessary to meet the demand of consumers and know where the products and their ingredients come from. This makes it more important to have good data on food products and the supply chain. Having and sharing authentic information from each and every step of the food supply chain enhances food safety, strengthens brand integrity, and increases customer loyalty.
The above highlights that, in order to be satisfactory, Bangladesh's monetary policy framework will have to give higher relative weight on output stabilisation than on inflation in contrast to the standard monetary policy paradigm.
ISSUE OF FISCAL DOMINANCE: Moreover, the fact remains that the central banks in countries like Bangladesh enjoy less independence which explains several macroeconomic outcomes related to monetary policy. One such issue is the fiscal dominance. In such situations, the political economy of decision making and the interaction between the banks and the fiscal authorities and other interest groups emerge as important dimensions of the outcome of monetary policy.
In Bangladesh, due to the existence of relatively underdeveloped financial markets, monetary policy is largely transmitted through the banking sector which becomes the most important channel of transmission of monetary policy. Perhaps more importantly, in the somewhat financially repressed economy, it isnot uncommon for Bangladesh Bank to operate through 'unconventional' tools (e.g. interest rate caps). This calls for a rethinking of the transmission channel in the presence of such tools including specific structure of the banking system.
Bangladesh has been fighting high inflation for a while but has so far failed to contain it. The fiscal year (FY) 2022-23 ended with high inflation, while we are now in the middle of FY 2023-24, but still there is no sign for the inflation rate to decline in a consistent manner. In fact, the rising inflation rate remains largely underpinned by surging food and fuel prices.
During the period, several countries including a few of our South Asian neighbours have managed to cool down their inflation rates. In Sri Lanka, inflation rate has been the lowest since 2021 and slowed to 4 per cent in August 2023. India, too, has eased its retail inflation, which is measured by the consumer price index (CPI), to 4.87 per cent in October 2023.
In contrast, Bangladesh's inflation rate went up to 9.93 per cent in October 2023 from 9.63 per cent in the previous month, reaching a five-month high. Prices accelerated for food and non-alcoholic beverages (12.6 per cent), housing utilities (9.1 per cent), clothing and footwear (8.2 per cent), furnishings, household equipment and maintenance (14.1 per cent) and recreation and culture (15 per cent).
While these countries managed to reduce inflationary pressure by adopting monetary policy tools, Bangladesh has been a late comer in doing the same. The policy rates were adjusted by Bangladesh Bank after a rather long lag.
BANK LENDING AND NPLS: In Bangladesh, the nexus between monetary policy and bank lending is highly complex. This shows a weak impact of monetary policy rate on lending activities of banks and financial institutions. The weak impact of monetary policy rate on lending is largely attributable to low levels of financial development, bank concentration, institutional weaknesses and a host of other structural factors that tend to weaken the potency of monetary policy transmission. Other factors that significantly influence bank loans are high incidence of non-performing loans (NPLs), capital adequacy ratio of banks, overall macroeconomic conditions and a culture of suppression of accountability.
The key for Bangladesh will be to enhance the effectiveness of monetary policy transmission on bank lending through effective use of the transmission mechanism of changes in money supply and monetary policy rate. Bank-specific factors that should be prioritised are quality management, reduction of NPLs, capital adequacy and sound risk management.
The other major source of money supply is high borrowing by the government from Bangladesh Bank. The central bank had to print Tk 700 billion to support the government's budget expenditure in the first 11 months of FY 2022-23. This money can multiply up to five times as it circulates in the economy, which means that the total amount of money supply from this operation was about Tk 3500 billion. This has inevitably fueled inflation.
Besides, there is also a large sum of money in circulation, which is easy money. This is the money that has not been earned by individuals or known sources such as employees or businesses. Brokers, middlemen, and rent seekers in various sectors of the economy have accumulated a lot of money without being involved in any productive activities. Corruption and wilful loan default are also contributing to increased costs of living. Loan defaulters are not really interested in investment in industries or any productive ventures which can create jobs. A portion of their defaulted money is laundered abroad and the rest is spent on their own luxuries in the country, which also contribute to price hikes. The amount of non-performing loans has increased to about Tk 1310 billion in 2023 from Tk 224.80 billion in 2009. However, when distressed assets in banks are taken into account, the amount of NPLs has been around Tk 3780 billion in December 2022, as per the Financial Stability Report 2022 of Bangladesh Bank. This is almost three times the amount of default loans of that year.
In the Monetary Policy Statement for July-December 2023, Bangladesh Bank took a stance for transition from a monetary-targeting to an interest rate-targeting framework. The central bank made a policy shift to a market-driven lending rate by withdrawing the lending rate cap. But monetary policy is not likely to work properly if the fiscal policy remains expansionary. In reality, there is no effective sign of austerity measures despite high inflation and low fiscal space. In the run up to the national election, public expenditure will further increase. Hence, the chances of success of the monetary policy adopted by Bangladesh Bank are rather bleak. There has to be a strong coordination between monetary and fiscal policies along with supporting actions in areas as discussed in this note. Instead of spending on things that do not demand urgency, the government should enhance support for the poor and low-income households and strengthen social protection to ease inflationary pressure on them. If high inflation persists for a longer period, the existing inequality in Bangladesh will escalate further from its already high state.
Dr. Mustafa K. Mujeri, Executive Director, Institute for Inclusive Finance and Development (InM). mujeri48@gmail.com