Asjadul Kibria

In a bid to contain the inflationary pressure, the Bangladesh Bank has gradually tightened the monetary stance. The basic idea is to curb the excessive credit growth so that money supply could be brought down within the limit set in the half-yearly monetary policy statement.

The BB has actually moved more aggressively during the second half of the just concluded fiscal year (FY11). Over the year, the central bank has increased reserve requirements once and policy rates for four times.

The International Monetary Fund (IMF) and some economists of the country are not happy with these measures as they found these inappropriate. To maintain macroeconomic stability, more tightening is a must, they said. That means, further rate hike.

As the time for semi-annual monetary policy announcement is very close, pressure on the central bank to hike rate continued. In this regard, a strong argument is references of India and China. The central banks of these countries have aggressively been tightening money supply to contain inflation. Reserve Bank of India (RBI) has increased policy rates for the 10th time within a year and a quarter. Bank of China also did it five times.

Before aligning the local trend with that in India, one should, however, closely look at the inflationary movement in that country. On average, Indian inflation rate was roughly 9 percent up to May reflecting limited impact of monetary tightening. Even, the RBI governor in May publicly admitted that their 'calibrated policy steps failed to tame inflation.' He, however, added that lag-effect would be there and so inflation would come down. In a similar vain, a deputy governor of the RBI in June said they have 'no magic wand to tame inflation.'

Indian analysts argued that the impact of rate hike is not uniform. At the beginning, when inflation was very high, it came down because of high base effect. Inflation rate was 14.86 percent in April last year and came down to 11.25 percent in July. Between August, 2010 and April, 2011, inflation rate hovered between 9.9 percent and 8.8 percent. But during the period, repo and reverse repo rates have increased 200 and 150 basis points respectively. Thus, after July, 2010, the inflation rate in India is actually fluctuating irrespective of the changes (hikes) in rates. So, drawing the example of RBI's aggressive rate hike move can be a good example of a central bank's continuous fight against inflation. But, it cannot justify the compulsion of monetary tightening in Bangladesh to contain inflation.

In fact, during the last fiscal year, the BB has hiked repo and reverse repo rates by 225 basis points each. These four rounds of rate hike by the BB are similar to 10 rounds of hike of repo rate by the RBI in 15 months. At the same time, the RBI, however, increased reverse repo rate by 275 basis points.

By using repo, banks borrow funds from the central bank. On the other hand, central bank mops up liquidity from the banks through reverse repo rate. By increasing repo rate, the central bank makes the loanable fund costlier, while higher rate of reverse repo indicates lucrative rate of interest for the banks to park funds with the central bank.

It is true that credit inflow registered huge growth during the just concluded fiscal year. Against the central bank's annual target of 17.9 percent growth of domestic credit, the actual growth stood at 28.3 percent at the end of May, 2011. Both the government and private sector borrowing from the banking system registered 32.8 percent and 27.5 percent rise at the end of May this year. The targets of these two aggregates were 25.3 percent and 16 percent respectively.

Moreover, money supply (M2) recorded 22 percent growth in May against the target of 15.2 percent. These are really a concern for the monetary authority. But, this does not mean that high money supply is the only reason for current upward trend in inflation in Bangladesh. Such monetarist proposition is no more convincing, although money supply is definitely an important driver of inflation. June figure is not yet available.

In fact, a policy note, prepared by the policy analysis unit of the BB a few years back, categorically mentioned that 'the relationship between the growth rate of M2 and inflation is relatively weak in Bangladesh.' It also said that 'although Bangladesh Bank is able to influence the monetary aggregates using the policy tools, the tools are losing effectiveness in controlling inflation in view of the increasingly complex nature of price dynamics in the country.'

Again, the current inflation is mostly driven by food inflation as reflected in the CPI (Consumer Price Index). In May, point-to-point inflation stood at 10.20 percent, while food inflation stood at 13.16 percent. Food inflation reached a double-digit level in December and continued to rise. On the other hand, non-food inflation rate was kept below 5 percent during the period under review. One can, however, question the accuracy of inflation calculation as non-food expenditures like transport fare have also gone up significantly for the last couple of months.

Despite such limitation, policymakers have to rely on the existing CPI data. Now, move to tighten money supply is virtually a move to dampen demand as monetary policy is recognised as demand management policy. As inflation is mainly driven by food prices, does tightening monetary stance means that peoples' demand for food has increased significantly? Does the higher inflow of credit push the peoples' demand for food?

One can, however, also question the programmed or target level of different monetary aggregates like government borrowing and private credit. Does the central bank justify its low level of targets with real world scenario?

The BB designed the monetary programmes to accommodate growth and inflation rate as well as estimated income velocity of money. In the last fiscal year, 6.7 percent real GDP growth and 7.5 percent annual inflation rate were in the mind to set the credit growth limits.

A big problem, however, is that monetary authority is overridden by the fiscal policy. To finance budget deficit, the government has heavily borrowed from the banking system at the end of the fiscal year. Worrisome part is that a good portion of the government credit was directly borrowed from the central bank. That is, the BB has to print notes. This is highly inflationary and goes against the central bank's tight monetary stance.

Against the backdrop, it is clear that monetary tightening is unlikely to contain inflationary pressure in near future. Even there is some lag-effect, and supply side constraints could not be addressed by monetary policy. Rather, there may be some success in restraining credit growth. Some signs of restraint are already there. It is now to see, how monetary authority sets stance for the first half of the new fiscal year keeping all these scenarios in mind.

Asjadul Kibria is the deputy business editor of Prothom Alo and can be reached at asjadulk@gmail.com.

News: The Daily Star/ Bangladesh/ July-13-2011