Couple of months ago, I analysed some indicators used by the Economist to see whether the Bangladeshi economy was overheating. The verdict was that ‘it was getting hot’. An overheated economy is not only more vulnerable to an external shock, it also usually leaves the policymakers with less options to boost the economy in case of adverse shocks.
In addition to their vulnerability indicator, the Economist also has a ‘wiggle room’ index for monetary and fiscal policy in 27 emerging markets. The concept is explained here, while here are country details. As of January, Egypt, India, Poland, Argentina, Brazil, Hungary, Turkey, Pakistan and Vietnam had little policy tools spared for a downturn.
That is, according to the Economist’s analysis, Argentina, Brazil, India, Turkey and Vietnam are economies that were dangerously overheated in mid-2011, and whose governments had little policy options to combat a downturn earlier this year. You wouldn’t want to be an econocrat in those countries!
What about Bangladesh? Over the fold, I look at the indicators for Bangladesh. Short answer: no room for monetary policy, but fiscal policy has spare capacity.
The magazine looks at five indicators to measure the room for monetary easing: inflation, credit growth, real interest rate, exchange rate, and the current account. Except for the exchange rate, these indicators also show up in the ‘temperature’ gauge. That’s partly why the overheating countries don’t usually have the room to ease monetary policy. Let’s look through these indicators for Bangladesh.
Inflation continues to be in double digits in Bangladesh. On this count, no room to move.
There seems to be little room to move on the second count — excess credit growth — either. Bank credit to private sector continues to grow at about 20%, about 5 percentage points ahead of nominal GDP growth.
At -2.3% in March, real interest rate — the difference between the policy rate and inflation — continued to be expansionary (though less expansionary than -3.8% in January. Nonetheless, even by this count little room to ease monetary policy.
The next indicator is exchange rate against the dollar. Currencies depreciating sharply — by double digit percentages over six months — are at risk of rising imports prices, which reduces the room to ease money. In the past six months, taka has depreciated by 10% against the dollar.
That is, so far we have zero out of four when it comes to ‘monetary wiggle room’. What about the current account, the fifth indicator?
According to the ADB, the current account is expected to move from a surplus of 0.9% of GDP in 2010-11 to a deficit of 0.5% of GDP in 2011-12 to a bigger deficit of 1% of GDP in 2012-13. Is this a cause for concern? Let me echo what I said about the current account two months ago:
If the country can avoid running up a large current account deficit, at least it will be spared a run on its currency. But can we avoid a larger current account deficit than what the ADB is projecting? What if oil prices rise sharply? What if the remittances dwindle? What if there is contagion from the rupee? What if, a la Krugman, there is speculative attack without any fundamental reason? Will we have enough reserves?
Overall, it seems to me that there is little room to ease monetary policy in Bangladesh. If the economy is hit by some shock, the Bangladesh Bank is in no position to help. It could, in fact, do a lot of harm if it tries to help.
What about the fiscal front? Here the findings has been quite surprising, at least to me.
The Economist has two indicators of fiscal flexibility. The first one is government debt as a percentage of GDP. The usual rules-of-thumb are that if debt isn’t stabilised around 60% of GDP, then the government has no fiscal room, while it’s time to panic when debt approaches 90% of GDP. Now, these are rules-of-thumb — there is no iron law that a country with 50% debt-GDP ratio won’t get in trouble, and some countries seem to do fine with over 100% debt-GDP ratio.
Of the countries the Economist looks at, Egypt, Hungary, Brazil and India have over government debt over 60% of GDP. In Bangladesh, as best as I can tell, government debt is about 30% of GDP — two-thirds of it to foreigners, the rest to domestic lenders.
If my calculations are correct — and this is so surprising that I need to check it against some published source, which will take time — then we have ample room to spend, not just if there is a crisis, but also to build infrastructure that we need.
The magazine’s other fiscal monitor is budget deficit adjusted for cyclical fluctuations. High budget deficits mean little room for further stimulus. India, Pakistan and Egypt have structural budget deficits over 6% of GDP. By my calculation (and I am a bit more confident about these), Bangladesh’s is less than 4% of GDP — not great, but by developing country standards, not too bad either. Plus, much of Bangladesh’s deficit is in development budget, which is financed through aid / grant / soft loans anyway.
So, to summarise, if things turn ugly, there appears to be room for fiscal policy, but not monetary policy, in Bangladesh.
The policy implications are a bit more tricky — and will be followed up in a later post.
(Data source: CEIC, Finance Ministry, BBS, Bangladesh Bank, IMF, and my own calculations which can be wrong).