Fiscal year 2006 was characterised by a high growth of domestic credit. Total domestic credit as compared to that of the previous fiscal year posted a rise of 20.2 per cent. While credit to Government (net) increased by about 22 per cent, credit to other Public Sector increased by about 35 per cent. Credit to the Private Sector marked relatively low increase of 18.3 per cent.

During the initial two months of the current fiscal year, point to point growth of the total domestic credit stood at 19.8 per cent. This marginal slowing down of the credit growth was mostly due to the slower increase of credit to the Other Public Sector (22.2 per cent). Growth of credit to the Private Sector remained steady at 18.1 per cent. However, credit to the government (net) during the July-August period went up by 25.6 per cent which was mentioned in our earlier discussion on financing of fiscal deficit.

The Bangladesh Bank should be encouraged to pursue an overall cautious monetary policy where aggregate credit expansion would remain moderately high (particularly given the inflation rate). The prime challenge before the CTG in the monetary sector CPD's Recommendations for the Caretaker Government 5 will be to sustain around 18 per cent credit growth in the private sector, while bringing down the demand for credit on the part of the government.

Government Borrowing
During FY06, government borrowing tended to move away from the non-bank sources to banking sources. While in June of FY05 the share of non-bank sources within the total outstanding borrowing was 59.0 per cent, at the end of FY06 (June 2006) the share had decreased to 55.8 per cent.

Sale of National Savings Deposit (NSD) certificates during FY06 registered a 35.6 per cent growth and repayment of the principal amount increased by about 41.0 per cent. Growth of net sale of NSD stood at 18.9 per cent. Borrowing from the banking sources increased by 23.3 per cent.

During July-August period of the current fiscal, sale of NSD certificates experienced a growth of 32.6 per cent. During the same period, growth of repayment of the principal amount experienced a drastic fall (8.9 per cent), resulting in a whooping growth in net sales (152.3 per cent). Outstanding non-bank borrowing stood at Tk40,362.82 crore, registering a growth of 9.5 per cent.

During the first two months, outstanding borrowing from the banking sources stood at Tk. 32,588.80 crore, registering a 25.6 per cent growth. Total government borrowing from both bank and non-bank sources amounted to Tk. 72,951.62 crore, recording a growth of 16.2 per cent. One can readily see the need for taming the government borrowing need.

Industrial Loan
During FY06, against the sanction of Tk. 13,582.27 crore, an amount of Tk. 9,650.02 crore was disbursed as term loan, registering a 5.9 per cent growth over the previous fiscal year (i.e. negative growth in real term). An amount of Tk. 6,759.52 crore was recovered during the period, resulting Tk. 2,890.50 crore as net inflow. The PCBs (Domestic) were the largest contributor (about 63 per cent), followed by Nonbank Financial Institutions (NBFIs) (a little more than 18 per cent).

On the other hand, disbursement of working capital during FY06 recorded a substantial growth of 28.3 per cent, while the sanction of working capital registered a 30.5 per cent growth during this period. During FY06 an amount of Tk. 28,448.53 crore was disbursed against the sanctioned amount of Tk. 24,691.92 crore. In terms of disbursement, PCBs (Domestic) accounted for three-fourth of the total disbursement of working capital.

No data on industrial term loan and working capital loan are available for the first quarter of FY07. However, taking note of the current state of play of public finance and trends in domestic credit expansion, and further being aware of the pre-election behaviour, it can be safely recommended that one should follow a cautious approach in industrial loan disbursement, without penalising good projects.

Agricultural Credit
Data on credit disbursement to the agricultural sector shows that Tk. 5,789.71 crore was disbursed during FY06, which is 16.8 per cent higher than the disbursement of the previous year (FY05). With the recovery of an amount of Tk. 4,123.91 crore, a net amount of Tk. 1,665.80 crore flowed into the rural economy during this period.

Initial data of the current fiscal year (FY07) mark a negative growth of agricultural credit disbursement. During the July-August period, total disbursement stood at Tk. 515.52 crore, which is about (-) 4.0 per cent lower than the disbursement of the matching period of FY06. Conversely, recovery stood at Tk. 497.55 crore, which is 6.3 per cent higher than the corresponding figure of the previous fiscal year.

This resulted in marginally positive inflow of credit to the agricultural sector. Consumer Price Index (CPI). Inflation rate at the national level showed an alarming rising trend during the FY06. The highest inflation rate (on point to point basis) for the last 77 months, i.e. about 8 per cent, was recorded in November 2005. Since then a steady decline was observed till February 2006 when it came down to 5.7 per cent. However, from March 2006 the inflation rate started to move up again and reached 7.54 per cent at the end of that fiscal year (June 2006).

Two major features of the price increase during FY06 can be identified. First, except in the month of March 2006, rise in price was higher in the rural areas than in the urban areas. Second, during FY06, other then January, February and March, inflation rate on point to point basis was much higher in food items than in the non-food items.

However, the first two months of FY2007 show some positive signs in the inflation rate trends. While in June (FY06), the general, food and non-food inflation rate on point to point basis was 7.54 per cent, 8.81 per cent and 5.73 per cent respectively, in the month of August (FY07), these rates were 6.67 per cent, 7.42 per cent and 5.64 per cent respectively. This happened largely because of the fall in food prices.

The 12-month moving average inflation rate for the general and food items also showed improvement as they went down from 7.16 and 7.76 per cent in June FY06 to 6.99 and 7.45 per cent in August FY07 respectively. However, for non-food items, it went up from 6.40 per cent to 6.43 per cent over the same period.

Cautiously moderate expansionary monetary policy was effective at the margin in bringing down the inflation rate. The recent appreciation of Taka may also have a sobering effect on the inflation rate. However, the CTG should rather strongly monitor and supervise the markets, especially the markets for essential products to locate the "syndicates" controlling the markets and take necessary measures against them. Since the Finance Adviser is also holding the portfolio of Ministry of Commerce, there should not be any problem regarding coordination among these two ministries. Regular monitoring of major distribution channels, such as importing and wholesaling points, would give positive results.

EXTERNAL SECTOR
The robust performance of external sector, experienced in FY06, has continued into the early months of FY07, providing the economy with some cushion in the current context. This is reflected in improvements in trade balance, current transfers and remittance and overall current account balance during the first few months of the current fiscal. This has also resulted in an increase in the reserve position in end- September 2006 compared to corresponding period of 2005.

Trade Balance
Thus, export growth, which posted a high growth of 21.6 per cent in FY06, has experienced a further growth of 32.6 per cent in the first two months of CPD's Recommendations for the Caretaker Government 7 FY07, at US$ 2,302 million. All major sectors have been experiencing high growth including knitwear (35.8 per cent) and woven-wear (30.3 per cent).

Over the corresponding period import posted a growth of 17.3 per cent, to reach US$ 2,450 million. The negative balance in trade in the first two months in the current fiscal year has reduced to (-) US$148 million from the (-) US$352 million of last year, thanks to higher growth of exports compared to that of import.

Although it appears that the spiralling petroleum price seems to have stabilised, and is even showing some downward trend in recent months from the highs of a few months back, it will be advisable for the Caretaker Government to keep a sharp eye on movements in the price of oil.

Higher L/C opening for consumer goods (22.4 per cent) against a relatively lower growth rate of L/C openings for industrial raw materials (7.3 per cent) and capital machinery (1.9 per cent) could be a cause for concern in the subsequent months. What is also somewhat disquieting is the low growth in the L/C opening (4.6 per cent) in the first two months of FY07 compared to the corresponding period of FY06 to compare L/C opening in FY06 was 19.6 per cent higher compared to FY05.

As regards the export, the appreciation of taka by about 3.4 per cent over the last few months could have a negative impact on export competitiveness of Bangladesh in the global market. In the context of the fact that most of the export earnings are being accrued on account of the volume rather than the price, the appreciation of taka was likely to have a depressing impact on profit levels for the export-oriented sector. In view of this, Bangladesh will need to give careful attention to exchange rate management in the coming few months.

Remittance income during the first three months of FY07 was US$1,328 million which was 24 per cent higher than that of matched period of last year. Remittance flow may increase further with the advancement of Eid and elections.

Current Account
In combination, all these have led to considerable improvement in the current account balance in the first two months, from US$99 million to US$414 million.

Forex Reserve
Accordingly, foreign exchange reserves at the end of September 2006 stood at US$3,447 million which was about 25 per cent higher compared to September 2005.

Prospect
Opening of L/Cs during the first two months of FY07 was 13.2 per cent higher than the corresponding period of last year, whereas L/C settlement was 15.5 per cent higher. These figures appear to be considerably higher compared to FY06 over FY05 when L/C opening and L/C settlements posted growth rates of 8.4 per cent and 10.2 per cent, indicating some pressure from the import side. In addition, higher growth rates of L/C openings and L/C settlements for petroleum and petroleum products, at 26.3 per cent and 20.7 per cent, during the first two months are also indicative of the pressure from the import side.

The overall BOP situation is sound and comfortable. The CTG will have to see that the current robust trends in export and remittances are sustained, whereas import demand remains moderate.

Foreign Aid Flow
One can observe from the figures on financing of fiscal deficit that off-take of foreign aid during FY06 as well as during the first two months (July-August) of FY07 was at its lowest ebb. Gross flow of foreign aid during July-August 2006 had been lower than US$ 96.0 million which is less than 41.5 per cent over the comparable period in FY06. Indeed, if one accounts for payment of the principal, the net flow turns out to be about 60 per cent less.

Under the circumstance, the CTG would need to take initiative to release, as much as possible, the project aid stuck in the pipeline and improve its access to budgetary support. (e.g. US$ 40.0 million of policy loan by the WB's Railway project).

The good news is that the IMF Board in its meeting held on 27 October 2006 has released about USD 50.0 mln under PRGF. But this disbursement will not diffuse the resource constraint of the government, as this is a BOP which is not available for spending.

(TO BE CONTINUED)

The writer is the executive director of Centre for Policy Dialogue (CPD).