Which way forward for the economy - policy treatment or vigilance over the system?

Amidst the global crises, inflationary pressure has begun to increase on the economy. Photo: Syed zakir Hossain

The Covid-19 pandemic caused the Bangladesh economy to stop growing in the second quarter of 2020, and shrinking became evident in most of its sectors. 

Following the initial surge and the introduction of vaccines, the economic shutdown was eased, leading to the timely implementation of special policies that successfully restored the pace of economic growth. This resulted in a growth rate of 6.94%, 7.10% and 5.82% (provisional estimation) for the years 2021, 2022 and 2023, respectively.

But in the last fiscal year, the promising economic revival unfortunately started to stumble because of several geopolitical and external adverse economic issues. 

The outbreak of the Russia-Ukraine war, trade disputes between the United States and the China-Russia bloc and tension in the Middle East have all had a significant impact on the world economy. The rising volatility in the forex market and the increasing dollarization of the global economy pose significant challenges for this emerging economy.
A decline in remittance inflow, reduced export demand from the EU market, and worldwide supply chain disturbances contribute directly to the imbalance in foreign exchange earnings for the Bangladesh economy. 

To preserve the dollar reserve, initiatives such as cross-border trades directly with the Russian Ruble, Indian Rupee and Chinese Yuan were introduced. The government implemented import limitations on non-essential and luxury goods, while simultaneously regulating the opening of Letters of Credit (LC) for machinery and capital goods. 

The government implemented various strategies to stimulate the flow of dollars via legal channels. They directed foreign missions to launch initiatives, conduct road shows, arrange meetings with delegates to explore new markets for product and labour force exports, and encouraged banks to draw in dollar deposits via offshore banking channels. 

Still, the inflow of dollars does not show any promising trend.

Recovering from the Covid-19 slowdown, Bangladesh Bank (BB), partnering with the government and several international donor agencies, injected special funds for entrepreneurs and industries to borrow at a lower cost, targeting almost every sector. 

Moreover, the cost of funds in the formal sector was strictly controlled, by charging any rate above 9% as an interest charge. As a result of comparative low-cost funds and intensifying global economic woes, inflationary pressure began to increase. 

The Bangladesh Bureau of Statistics (BBS) calculated the inflation rate as 5.69%, 5.54%, 7.70% and 9.48% for the years 2020, 2021, 2022 and 2023, respectively. 

However, reports from think tanks and commodity markets suggested that this inflation rate was closer to double-digits. Adding more difficulties, the dollar crunch also made the situation worse, and the pressure of currency devaluation appeared on the scene. 

The increase in demand for the dollar, coupled with a lack of response from the supply side, led to a reduction in the foreign exchange reserve, ultimately forcing the country to devalue its currency. 

As the dollar stock continued to drain, the IMF's prescription had to be followed, and eventually, the exchange rate entered the crawling peg rate system. Another policy change is that BB abandoned the SMART rate for interest rate calculation and instructed the industry to follow a market-based rate. 

In this very short time, the cost of borrowing jumped to double digits from single digits. This change in BB's stance simply implies a strict adherence to the thumb rule, which is, increasing the cost of borrowing funds in an attempt to reduce inflationary pressure. We can interpret this higher interest rate as a contractionary monetary signal for the market. 

We expect a high cost of funds due to the transmission effect of the money supply to lower the price level and reduce inflationary pressure, but is this the only outcome we aim for? 

In response to this question, economists once again caution that alternative scenarios could emerge. For instance, the economy could slow down due to the recessionary trend in the business cycle, or worse, it could enter a vicious cycle of stagflation, characterised by no growth but a volatile price level and inflationary pressure.

The Bangladesh economy is currently at a critical juncture in its growth trajectory. The take-off period has begun. It requires precise policy actions to avoid potential negative impacts on growth performance. 

Bangladesh's development targets include graduating LDCs by 2026 and crossing the upper-middle income threshold by 2031. These two years serve as crucial reference points for navigating and promoting the economy's growth trajectory. 

In this period, should BB continue its traditional role of preparing economic policies, or should it also take on the role of guardian angel for the financial ecosystem?

Bangladesh's economic sector does not have the characteristics of a standard model of financial system, and different constraints are always having negative impacts on financial stability. 

Classical instruments to curb inflation take a long time to achieve targeted goals. A timely, exact notion of policy or instruction may fail to bring desired stability in the price level or the growth rate for the economy because of this reason. 

Meanwhile, there is a scope for the BB to take on some unorthodox activities to ensure the policy works. 

The BB should not only implement the policy on time, but also actively monitor the economic sector, ensuring that all stakeholders in this economic arena behave cleanly and precisely. 

Policy synchronisation with the government, over and above the proper strict management of the all-financial entities at the micro- and macro-levels of the economy, needs to be the utmost priority from the regulator for ensuring smooth and well-timed reach of its macroeconomic targets. 
 

Shitangshu Shekhar Roy is the Joint Director of Bangladesh Bank.

isclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.