On the monetary policy in Bangladesh
An IMF team has recently concluded a two-week-long visit to Bangladesh for reviewing the country’s economy. The visit was for the annual ‘Artcile IV’ consultation process. This consultation process involves IMF economists visiting the member country to gather information and hold discussions with bureaucrats, private investors, and other stakeholders including politicians, labor representatives, civil society organizations, and academics. The economists then submit a report to the Fund’s Executive Board. The Board reviews the report and sends it to the country’s government. At this point, a press release is issued. If the government agrees to it, the report itself is published.
As far as I can tell, full reports for Bangladesh were released in 1998, 1999, 2002, 2003, 2005 and 2007. I’m not sure if a full report is forthcoming this year. Here is the official press release. Highlights:
- Macroeconomic performance was remarkably resilient in a year of multiple natural disasters and elevated international food and fuel prices;
- The main priority is to keep control of inflationary pressures stemming from global prices and domestic demand.
- [D]espite the sizeable allocations made in the budget, recent movements in international commodity markets suggest that additional spending for fuel and fertilizer subsidies will likely be required.
The second point has received considerable attention in the media, and is the focus of this post.
The Daily Star covered the relase with this heading: IMF suggests tight monetary policy. The New Age covered it thus: IMF asks for less expansionary policy. Local economists, however, seem to have rejected the advice.
So, exactly how expansionary is the monetary policy setting in Bangladesh?
One way to assess the looseness of the monetary stance is to look at the real interest rate. We can derive the (realised) real interest rate by using the interbank call rate (the rate at which banks transact with each other) and inflation. The lower the real rate is, the looser the monetary stance, and negative real interest rate means a very expansionary stance.
Chart 1shows that while for much of 2007 the real interest rate in Bangladesh was negative, it rose sharply in March and April of this year. Chart 1 also has real interest rates in Indonesia and Pakistan for comparison – both countries seem to be experiencing gradual loosening (or failing to tighten) of the monetary stance over the past year.
Chart 1: Real interest rate
So the monetary policy is not as loose as the IMF suggests? Well, not quite. I have inflation data only up to April. SInce then, interbank call rate has fallen from 15.48% to 10.72%. Since inflation is likely to be hovering around 10% or so, the real interest is likely to be close to 0%. While this is not as expansionary as in 2007, it definitely is not tight.
Thomas Rumbaugh of the IMF team explicitly mentioned credit growth to Dhaka journalists as being too high. The media however has been reporting that the local businesses are facing a ‘liquidity crisis’ lately. Chart 2 shows that the growth of credit to the private sector has actually risen in recent months, supporting the IMF contention.
Chart 2: Credit growth and inflation
More alarmingly, the chart also shows that there is a somewhat of a lagging relationship between credit growth and inflation – a rise in credit growth today shows up in higher inflation a year from now. This is particularly worrying because it means that even if the banks were to tighten credit flow right away, there is probably already too much money in the system to keep inflation high.
And that is without any supply shock to the food and fuel markets. Discussions at a recent seminar suggests that at least as far as food is concerned, the expectation is definitely of continued inflation.
However, there may be some light at the end of the tunnel. One gauge of inflation expectation is long-term bond yield. If they go up, that’s an indication of increasing inflation expectation (they can also mean increased risk). As Chart 3 shows, bond yields actually fell in the second half of 2007 and hasn’t risen since.
Chart 3: Government bond yield
As the first half of 2008 has been marked by increasing risks from the global financial crisis and domestic political uncertainty, the bond yields may be telling us that the market doesn’t expect inflation to be rising into the medium to longer term.
If that’s the upside, the downside is that both the IMF and local economists are probably right about the domestic monetary stance. The IMF is right in that the monetary stance is definitely not tight enough to combat inflation. While they concede that some inflation is inevitable given global food and fuel market developments, they correctly argue that loose monetary stance is likely to further fan inflationary pressures. But the local economists are also right in that a monetary tightening to stem the flow on effects of food and fuel inflation is going to work only by hitting businesses hard.
Update (18 July)
Bangladesh Bank has just announced its monetary policy statement for the 2nd half of 2008. Highlights:
- Targetted GDP growth of 6.5% and inflation of 9% or less in the 2008-09 financial year.
- While the Bank will monitor credit growth, it’s not going to pursue monetary contraction because of adverse impacts on economic growth and poverty alleviation.
- Bangladesh Bank will try to maintain exchange rate stability.
An executive summary (in Bangla) is available here.