Inflation is a sustained increase in the general price level in a country usually measured at the retail level using what is normally called the Consumer Price Index (CPI). The annual rate of changes in this price level, measured by the CPI, is the rate of inflation. Inflation causes changes in the level and distribution of real income within a country or across national boundaries as well as in growth and trade.
Inflation does not limit its negative impact on real income, reducing purchasing power of general consumers. Inflation distorts the functioning of the price mechanism, therefore, Inflation primarily causes prices and costs of goods produced in any country to rise rapidly making them more expensive relative to goods produced in other countries. To put it differently, when inflation drives up the price of goods and services within an economy, that nation becomes less competitive in the international market. This means that the 'balance of trade' is altered and demand for currency declines.
Rising inflation also negatively impacts on goods and services trade, it also distorts the international movement of capital. It discourages inflow of capital, particularly to developing countries and but more ominously fosters capital outflows from these countries. Therefore, Inflation generally tends to change exchange rates and balance of payment accounts. Trade is also both a lead indicator and a conduit of global inflation. Price increases through trade is evident in the aftermath of the Russia-Ukraine conflict.
Rising inflation has been the economic story since 2022 and is continuing. Rising food and energy prices have impacted the cost of living in both developed and developing economies. According to OECD Secretary General Mathias Cormann, trade flows around the world show us how inflation is contributing to a structural shift in the global economy.
In early October in 2022, the World Trade Organisation (WTO) indicated global trade growth to slow sharply in 2023 as the global economy faced strong headwinds. WTO economists revised their forecast for merchandise trade to grow by 1 per cent in 2023 instead of 3.4 per cent as predicted earlier.
The WTO also in April this year predicted that global trade might experience the biggest drop since the Great Depression and to contract by as much as 32 per cent. Such a slowdown in global trade needs to be viewed through trade-growth nexus where growth will be impeded by rising inflation which causes substantial resources being wasted in inefficient transactions and speculations and above all it distorts the price mechanism leading to resource misallocation.
The United Nations Conference on Trade and Development (UNCTAD) in its global trade update released on December 13, 2023 made the prediction that global trade had "turned negative" after a record year due to inflation. While global trade is set to reach almost US$32,000 billion this year (2023), the downswing that began in the third quarter of 2023 is likely to continue.
UNCTAD further added "Geopolitical friction, persisting inflation and lower global demand are expected to negatively affect global trade during 2023". UNCTAD expressed a generally negative outlook for 2024 and said that the outlook for 2024 remains "highly uncertain and generally pessimistic".
UNTAD attributed the decline in global trade partly to export underperformance of developing countries. But high interest rates to tame rising inflation in many countries have also impeded commercial activity. While headline inflation has been declining in major advanced economies including the US, core inflation remains persistent. According to the OECD, headline inflation is projected at 2.6 per cent in G20 countries in 2024 while core inflation is projected at 2.8 per cent during the same year.
As Russia cuts energy supplies to European Union (EU) countries, energy prices skyrocketed further adding to the inflationary pressures. As trade has been used strategically in foreign policy and has been weaponised by western countries, the outcome is inflation which affects everybody.
As inflation continues to persist, central banks are raising policy rates which dampen households' and firms' demand including import demand through higher borrowing costs. As such economic conditions are expected to deteriorate in 2024. A slowdown in economic growth will certainly create an unfavourable environment for trade. But the collective slowdown is likely to play out differently across countries depending on their sensitivity to changing interest rates and structural differences.
Also, as the world has gone past the peak of globalisation and that has been putting downward pressure on global trade growth. Global economic growth will certainly be less than this year's as central banks are aiming at inducing a slowdown to regain control over inflation and that will negatively impact on trade.
In fact, what we are witnessing now is the process of deglobalisation as reflected in trade/global GDP ratio which declined from 25 per cent in 2008 to 20 per cent in 2020. We are also experiencing the after-effect of deglobalisation - increased inflation systematically.
The primary impact of inflation is decreasing purchasing power. Although the denomination of the currency does not change, the impact of inflation is that the same amount of currency can buy less across inflationary periods. Bangladesh has been experiencing a rising inflationary trend since the late 1980s. Between 1987 and 2022, average inflation rate was 6.5 per cent. It is estimated that the purchasing power of 100 taka in 1987 corresponds to that of 889.06 taka at the beginning of 2023 (see WordData.info).
As growth is moderating as the impact of tighter financial conditions resulting from central bank's policy rate hikes to tame inflation, business and consumer confidence is declining. This in turn is weakening trade growth. According to the Financial Express (January 3) Bangladesh experienced a significant downturn in its exports in the first half of current fiscal year (July-December, 2023) achieving only 0.8 per cent growth.
Looking further outwards to trade, a downturn in Bangladesh's major export destinations weighed on demand for the country's exports, principally RMG. The US and the 20-nation euro currency bloc, the two principal destinations for exports are expected grow by 1.5 per cent and 0.8 per cent respectively in 2024. Therefore, the combination of flagging output growth and continuing inflationary pressures in these countries will likely weigh heavily on Bangladesh's exports growth in 2024.
However, it is to be noted that exports account for a very low share of GDP which fell to 15.32 per cent in 2019 from a peak of 20.16 per cent in 2012. It further fell to 12.18 per cent in 2020 and now for 2022-23 it stands at 7.7 per cent indicating declining international competitiveness of Bangladeshi exportable.
With imports outstripping exports, Bangladesh is not only running a deficit on the current account but in the financial account as well in its balance of payments. During the fiscal year 2022-23, Bangladesh ran a current account deficit of US3.34 billion and a financial account deficit of $2.14 billion during the same year. The country is also experiencing a fall in foreign direct investment further adding to the problem.
However, during July 2023 - November 2023, Bangladesh achieved a current account surplus of UU$579 million but continued to run a deficit of US$ 5.4 billion In the financial account during these five months. Consequently, Bangladesh's balance of payments remained in deficit to the tune of US4.9 billion indicating an unchanged situation facing the overall balance of payments. It is to be noted that during this period imports declined by about 21 per cent while exports grew by only 1.2 per cent (see FE, January 5). The current account surplus was achieved primarily through declining imports, and this has implications for the inflation outcome in Bangladesh.
Continuing balance of payments difficulties is also reflected in the declining foreign exchange reserves. It appears the reserves crisis is having an impact on imports. Imports declined by about 21 per cent between July and November this year as the central bank is tightening its grip on import flows of what is described as luxury goods. But such a direct intervention to control imports by the central bank is consistent with countries experiencing declining foreign exchange reserves but it is unlikely to resolve the reserve crisis. In fact, trying to address the reserve problem via import controls can lead to creating problems somewhere else such as growth, inflation, revenue collection etc.
Continuing balance of payments difficulties are also causing the taka to depreciate against the US dollar. But rising inflation has also weakened the currency. In fact, the US dollar appreciated by 23 per cent against a broad basket of other currencies between January 2011 and December 2019, and has continued its appreciation since then. Federal Reserve Chairman Jerome Powell stated his commitment to maintaining a strong dollar and high interest rates in the US which tend to support the strong dollar internationally.
Despite the taka depreciating, Bangladesh yet could not achieve price competitiveness as reflected in its trade balance. The reasons for such a lack of competitiveness possibly lie elsewhere which need very careful examination. However, Bangladesh seeking to strengthen its exchange rates, higher interest rates and stronger economic fundamentals would help.
It is estimated that the taka depreciated by 31 per cent over more than a year to November 2023 (see FE, December 11) and the currency depreciation often contributes to inflation. In fact, Bangladesh is now facing rising inflationary pressures - inflation reaching 9.5 per cent in November this year. Then inflation in turn feeds into rising costs of production of exportable and making import competing industries less competitive in the domestic market leading to a trade deficit.
However, Bangladesh appears to be holding down the annual rate of change in the exchange rate by overvaluing the taka with the hope that can put downward pressure on inflation. The major way that inflation affects international trade is through its relationship with currency exchange rates by altering relative prices and costs to stimulate or dampen international transactions in goods and services. But it is productivity growth that makes it easier for firms to offset rising costs. In fact, it is the key factor in keeping a lid on inflation.
On macroeconomic issues such as inflation, the influence of general equilibrium theory, inflation-unemployment tradeoffs, and monetarism remain strong. But the root causes of inflation, as explained by economic theory, remain unsatisfactory. To dig beneath these general theoretical tendencies requires that we identify and analyse the factors which underlie and drive inflation. These factors are likely to include escalating food and energy prices, fiscal and monetary policy actions, non-competitive markets, inflation expectation, rising input costs and others.
Policymakers in Bangladesh appear to prefer to keep the taka overvalued by resisting devaluation at least partly possibly on the ground that it would further add to rising inflation and worsen balance of payments problems. But such an attempt to alter inflation and exchange rates via policy maneuvers or even occasionally through administrative means instead of allowing the market forces to play a greater role is unlikely to yield the desired results.
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