Of all the policy instruments used by a government to guide the macro-economic variables along desired trajectory fiscal and monetary policies occupy centre stage. Unlike other policy instruments like trade policy, industrial policy, etc. that concerns particular sectors of the economy the reach of fiscal and monetary policies is all-encompassing, cutting across all sectors. In fact, the other policy instruments piggyback on these two pivotal instruments for their successful operation. Together these two policy instruments and their operational mechanism for transmission determine the course of an economy.
To be effective in their dominant roles it is not always enough to be mutually supportive. In terms of creation of maximum synergy for taking the economy ahead, monetary policy has to complement fiscal policy, assuming an overtly supportive role. This is particularly so in a developing country like Bangladesh where the government has to provide momentum to all the sectors of the economy through direct and indirect fiscal measures. By the same token, an ill-conceived fiscal policy can impinge adversely on sectoral growth through misallocation of resources and egregious disincentives. In this scenario, monetary policy, however well-formulated, can do little to attenuate the damage. In Bangladesh, fiscal policy has so far steered clear of a reckless path eschewing ballooning public debt and runaway inflation. The country's debt to gross domestic product (GDP) ratio has been well within the safety limit, being below the GDP growth rate.
The moot point is whether and to what extent the overarching objectives of fiscal policy viz. sustainable and inclusionary growth with financial stability have been supported by 'accommodative' monetary policy. Being accommodative, of course, does not mean monetary policy has to be the handmaiden of fiscal policy playing a subservient role. It would be ideal if the finance ministry consults or takes into confidence the central bank (Bangladesh Bank) before finalising fiscal policy embodied in the annual budget. Various compulsions of governance that partake of political economy do not always lend themselves to seamless co-ordination and conflation with monetary policy, at least not in any meaningful way. Though the central bank is not ignored in pre-budget discussions it may be led to compromise over fundamental monetary policy objectives. For instance, the central bank may suggest a minimum level of deficit financing to stem inflationary pressure. But the government having obligations to sustain on-going activities of both non-development and developmental vintage and to undertake new initiatives is hard put to extricate itself from deficit of a magnitude that it deems necessary. As a countervailing measure the central bank may then take recourse to raising the policy rate for lending to commercial banks. This, together with a policy decision to increase the capital adequacy ratio (within the BASEL III agreement) to be maintained by banks may keep incipient inflation under leash. But it may come into conflict with fiscal policy ushering in credit crunch impacting on investment for growth. The primary objective of fiscal policy will thus be in jeopardy.
The conflict between fiscal and monetary policy in times of inflationary pressure becomes all too acute. While the former is interested to have more money in the government coffer to defray revenue and development expenditure, the latter has a traditional bias against expansion of broad money and spike in credit disbursement that may usher in financial instability. The central bank is not only worried about rising inflation per se, but also over exchange rate fluctuation fuelled by inflation that may affect foreign trade and current account balance. The resolution of the conflict becomes easier when budget for a year is prepared in the backdrop of inflation in the single digit, preferably below the rate of GDP growth. This process is further helped if there is significant savings by individuals and institutions accessible to investors through banks.
With this rather lengthy preamble it can now be considered whether the monetary policy for H1 of the current fiscal is in convergence with the budget for 2016-2017. By all accounts, including the admission of the finance minister, the budget has been very ambitious with record revenue income projected and massive expenditure envisaged. As hinted earlier, the compulsion for this was rooted in political economy that called for a high level of expenditure for both non-development and development activities by the government so as to attain, among other objectives, the targeted goal of 7.5 per cent GDP growth by the end of the current fiscal, rising from the rate of 7.02 per cent achieved towards the end of the last fiscal. This overarching objective inevitably led to a budget based on deficit financing. This could give rise to worry for Bangladesh Bank because of possible bank borrowing by the government as in the past. But to its utmost relief bank borrowing by the government has seen negative growth during the last six months (January-June 2016) as the deficit was mostly financed through alternative channel of national savings certificate. But Bangladesh Bank expects bank borrowing by the government by the end of the year (December) because of growing burden of debt servicing obligations.
The present mode of deficit financing and the possibility of delayed bank borrowing have relieved the central bank from worry about immediate rise in inflation. This feeling of relief has been further bolstered by the fact that against the targeted inflation rate of 6.07 per cent during H2 of the last fiscal the actual incidence of inflation was 5.90 per cent. According to recent data, the inflation rate has come down to 5.4 per cent which is lower than the targeted rate of 5.8 per cent fixed for the current fiscal. The rate being below the GDP growth of 7.02 per cent the central bank has felt confident to keep the policy rates unchanged in the recently announced monetary policy statement (MPS) where the repo and reverse repo rates remain at 6.75 and 4.75 per cent respectively. After the benchmark rate revision during the last fiscal credit disbursement registered remarkable growth in the private sector. Point-to-point private sector credit growth up to May 2016 was almost 150 per cent higher than targeted. In view of this surge in private sector credit growth the target for the same has been fixed at 16.60 per cent in the current MPS. Public sector credit growth during January-June 2016 was in the negative territory (because of use of national savings certificate). Anticipating a winding down of this dependence on national savings certificates by the government the MPS has prudently fixed a target of 11.90 per cent of credit growth in public sector during the current fiscal.
The provision of credit growth both in the public and private sectors is consistent with the growth of broad money which is targeted to increase by 14.80 per cent as against 14 per cent during the H2 of fiscal 2015-2016. The expansion of broad money has been due to the record amount of saving deposits in banks. While unchanged policy rate creates the possibility of increasing liquidity in the financial market, the actual availability of savings deposits assures immediate access to credit by investors, fulfilling the fiscal objective of adding momentum to GDP growth to the targeted rate of 7.5 per cent during the current fiscal. The incident of inflation at 5.92 per cent during January-June 2016 and very strong likelihood of a downward trend because of fall of prices of oil and other commodities gave confidence to Bangladesh Bank that its prime objective of maintaining price stability will not be at risk because of expanded broad money supply and unchanged policy rate. The accommodative MPS is likely to yield results that would be best of both the worlds, i.e., growth and financial stability.
The exchange rate affects both growth rate (through exports and imports) and price stability and therefore is of strategic importance in fiscal and monetary policy. In the present MPS the exchange rate has been kept unchanged both for price stability and export competitiveness. The MPS envisages 'maintaining orderliness in transition to new market equilibrium in response to pick up in investment and consumption-driven import vis-a-vis rising trends of exports receipts and other inflows (remittance ?). This implies that Bangladesh Bank will not be averse to fine-tuning the exchange rate to reach new market equilibrium reflecting changes in demand and supply of foreign exchange. Here one gets hints of a strategy for foreign exchange management that is somewhere between a floating and managed exchange rate regime that may be pressed into service depending on the exigency of situation. The present policy of buying foreign currencies to prevent fluctuation in the value of Taka is therefore likely to be given a new makeover, if and when the need arises. This orientation of MPS should take care of both stimulus to growth and financial stability.
From the above analysis it is seen that without sacrificing independence (read price stability), Bangladesh Bank has accommodated the need to complement fiscal policy. It is not known to what extent the implications of the current fiscal policy were taken into account by Bangladesh Bank in formulating the latest MPS but it is almost certain that no agonising exercise was necessary to ensure convergence of the two polices. This has been possible because of the favourable macro-economic environment prevailing.
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