Checking inflation with contractionary policy a tough job

Currently, the country's economy is experiencing high inflation, posing several challenges in macroeconomic terms. Among these challenges, high inflation stands out as the most significant. To address this inflationary pressure, various initiatives have been undertaken, with notable emphasis on monetary policy. However, the recent announcement of monetary policy by the Bangladesh Bank appears to be conservative in nature. The Bangladesh Bank believes that a conservative monetary policy will play a supportive role in controlling high inflation. However, this initiative has been delayed. Furthermore, it is uncertain to what extent conservatism will be sufficient in controlling high inflation because inflation is not solely caused by one factor. There are many other factors contributing to inflation. Therefore, controlling high inflation through conservative monetary policy alone will be challenging.

One significant factor behind high inflation is the US dollar crisis. Due to the scarcity of the US dollar, sufficient imports are not feasible, particularly hindering the importation of industrial raw materials, capital machinery, and intermediate goods. As a result, production is being affected. If the US dollar crisis cannot be resolved, it is doubtful that controlling high inflation solely through conservative monetary policy will be possible. The Bangladesh Bank is attempting to reduce expenditure indirectly. However, there are certain items that, if not imported, will disrupt production. It would be beneficial to reduce the importation of unnecessary and luxury goods. Nevertheless, it will not be feasible to reduce the importation of various essential industrial tools and equipment. Controlling high inflation through conservative monetary policy will not be straightforward. It is unlikely that inflation will decrease solely due to conservative monetary policy. However, at this moment, our most urgent task is to bring high inflation under control and stabilize it at a sustainable level.

Another major cause behind inflation is the inability to properly manage the market. In our country, market management is not adhering to the principles of a free market economy. Nowadays, we see various types of warnings being issued by the government from different levels to prevent price hikes in the market. However, controlling the situation solely through warnings will not be effective. For this, appropriate preparations need to be made to take control measures. But do we have those preparations? We have a rough idea of how the market is functioning. However, to control the situation, actions need to be taken. Mere words will not suffice. We must utilize the opportunities available under competition laws to ensure proper and fair market management. Taking such measures must be done swiftly. If punitive measures can be taken within the framework of the law, then even if the situation improves slightly, there will be progress. The tendency to hoard in the market, which we often observe, must be effectively addressed. Sometimes, prices of certain goods escalate abnormally. This must be strictly controlled.

It is often heard that businessmen syndicates exist in the market. While there may be syndicates in some sectors, it is not necessarily the case across the board. Observing market behavior, it seems that some force is manipulating the market. It cannot be conclusively stated whether this is through syndicates or by other means. Sometimes, the market becomes unstable, and efforts must be made to identify the cause and implement measures to counteract it. It is necessary to identify who is involved in such activities and how they are being carried out to take appropriate punitive action. The authorities have previously attempted to control the market by arbitrarily fixing prices on various goods, but this has not yielded any significant results. If those responsible for increasing prices unjustifiably cannot be restrained, how will the situation be brought under control? It is observed with astonishment that suddenly the price of a particular product in the market increases abnormally. Failure to take effective measures will lead to the perpetuation of such situations.

Before the national elections, the price of beef per kilogram suddenly decreased from Tk 800 to Tk 600 in the capital's market. However, after the elections, there is a visible trend of price increase in beef. Already, the price per kilogram has risen to Tk 700. It is speculated that it will increase again to Tk 800 in the future. There are different interpretations regarding this fluctuation in beef prices. Some argue that where the price of beef has decreased, there was excess bone and fat, meaning the quality of the beef was lower. Due to a higher quantity of bone and fat, the actual amount of meat in the beef was lower. Therefore, businessmen reduced the price of beef, but it is believed that the real issue lies elsewhere. However, even then, it cannot be conclusively stated why the price of beef suddenly decreased and then increased again without having accurate information. Therefore, it is not possible to assert anything with certainty on this matter. I do not know whether the manipulation of beef quality was done through syndicates or by other means. Further investigation is needed to ascertain the matter.

Central banks of at least 77 countries around the world, including the United States, have extensively raised policy rates to control inflation. This leads to a proportional increase in bank loan interest rates. It affects the currency supply in the market. However, when the Bangladesh Bank raised the policy rate, it did not have much impact on the market. This is because despite the increase in the policy rate, the banks maintained the 'upper cap' of 9 percent on loan interest rates. As a result, even though the policy rate increased, the interest rates on bank loans did not rise. This did not reduce but rather increased the influx of money into the market. In this situation, increasing the policy rate did not raise any questions about reducing the influx of money into the market or controlling inflation. Since July, after determining the interest rate through smart methods, the increase in interest rates in the market has not been sufficient. This is because in this situation, banks cannot determine interest rates based on market demand. The impact of this method has not yet fully reached the market. These steps have come late. It is not certain whether the increase in bank loan interest rates will have any effect on inflation. It cannot be said with certainty yet. Observations over the next few months may help determine the trend of inflation.

It cannot be definitively stated how much inflation a country, especially one like Bangladesh, can tolerate in its economy. It is not realistic to expect zero inflation in Bangladesh's economy. As an economist, I believe that if the average inflation rate can be kept below four or five percent, it could be considered tolerable. Similarly, if the wage rate continues to increase in line with inflation, it could also be considered tolerable.

To mitigate inflation, market management needs to be improved. Efforts must be made to reduce the dependency on the US dollar, as seen in the current crisis. Any contractionary position in monetary policy must be maintained until inflation reaches a tolerable level. To address the current crisis with the US dollar, efforts should be made to increase dollar inflows and reduce dollar spending. A significant portion of dollar inflows comes from remittances. Measures should be taken to ensure that remittances flow through formal channels. If those purchasing dollars through formal channels cannot compete with informal market rates, dollar inflows will not increase. Primarily, this is why it is being suggested to marketize the exchange rate of foreign currencies. The Bangladesh Bank is considering making the exchange rate of foreign currencies market-based. However, they are taking extra time in this regard. Because the crisis is currently ongoing, actions need to be taken immediately to address the situation.

If we simply say that the exchange rate of foreign currency will be market-based, but quick measures are not taken, the created crisis will not be alleviated. Some argue that if the exchange rate of the US dollar is market-based, import costs may increase abnormally. However, this notion is probably incorrect. Currently, importers are buying each US dollar at around 122/123 Bangladesh Taka, which is much higher than the official rate. Thus, even without the Bangladesh Bank announcing a market-based exchange rate for the US dollar, its value has already entered the market. By making the exchange rate of the US dollar market-based, its inflow will increase. Moreover, besides relinquishing control over the exchange rate, there are many other measures being taken to reduce import costs.

If the exchange rate of foreign currency is made market-based, the inflow of foreign currency will increase. In such a situation, the strict measures being taken to control current imports and expenses can be relaxed. This will contribute to an increase in the influx of goods into the market, which, ultimately, will contribute to reducing inflation in the long run. Many exporters leave a portion of their earnings abroad. They believe that if the value of the US dollar increases against the local currency, they will bring this money back into the country. If the exchange rate of foreign currency is made market-based, exporters will be encouraged to bring back their entire export earnings to the country. Regulatory authorities must work independently to control those involved in economic smuggling. Their efficiency must be enhanced.

Author: Economist and Former Lead Economist, World Bank, Dhaka Office

Transcribe: M A Khaleque