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No quick fix Forrest Cookson runs his eye over what 2008 might have in store for the Bangladesh economy Is the Bangladesh economy in serious difficulty? Yes. Will we see a continued slow down of the economic growth rate? Yes. Will the inflation continue in double digits? Yes. Is the worst over? No. Are there any policies that will make much difference over the next two years? No. Is there enough food in the country? Yes. The reasons for this pessimism are outlined in this article.
First, most of the shaping factors are external and those that are internal have been building up for years. Second, modern economies change very slowly. While there are important policies to implement the impact of these over the next two years will be limited. Governments all over the world have the illusion that their actions make a difference -- sometimes this is true but only over a relatively long period of time. The most serious research in economics suggests that government policies have little impact! Of course it is important for government to put in place policies that will make a difference over the next decade. But one should not expect an immediate response of the economy. The key policies that will help in the long run are easy to identify: government should put in place a serous export led growth policy. The government should get out of the business of producing goods and services. Instead it should concentrate on improving and implementing sound regulatory programs. The government should minimise the regulations that it imposes and should seek to promote competition by deregulation. The objective should be to help markets function effectively. Bangladesh is faced with pressures on the economy from external sources. First, the inflation is imported from the rising prices of goods in dollars and particularly the revaluing Indian rupee with respect to the dollar. Second the prices of oil, steel, food and most capital equipment are increasing or have increased well above dollar levels of two years ago. Third, the world economy has started to slow and this will continue over the next several years weakening export demand but ultimately reducing the imported inflation. There are some internal developments partly linked to the international changes. In particular the inflation is causing both the current account and government deficits to rise; there are growing labour problems linked to the inflation. The natural disasters of the past year have increased the government deficit as every effort is made to repair the losses. The events of January 11, 2007 have caused a major decline in private sector investment. This is not to suggest that the January 11 revolution was not appropriate, but one must face up to the consequences of these necessary actions and one of these was a sharp reduction of private sector investment. Is the economy in serious difficulty? Yes. Slowing growth and continuing inflation are a terrible combination. The lower 75% of the income distribution will find their standard of living even worse. Slower economic growth is having a negative impact on employment growth. Within the informal private sector there is much activity to increase income and to find things to do; the Bangladeshi worker does not remain idle in the face of adversity. Will we see a continued slow down of the economic growth rate? The slow down in growth arises from a decline in private sector investment and slower growth in net exports (i.e. exports net of the imported components). This drop in aggregate demand will not be offset by the increases in expenditures arising from the inflow of the remittance flows or government expenditures. Fiscal policy to increase the deficit is probably not possible with the present economic configuration. Indeed the strongest calls will be for a reduction in the government deficit. (This of course is exactly the wrong response to the situation Bangladesh is facing but that does not mean it will not be called for by many.) Monetary policy will not be able to influence the private sector investment demand which is low due to the high level of uncertainty that the entrepreneurs perceive, both about their own future and the future demands for their products. Everyone knows the, facts but I will restate them: Import of capital equipment is down in dollar terms and is even less in real terms since much of these goods comes from Europe or Japan whose currencies have appreciated with respect to the dollar. Thus, if the machine costs 100 euros in 2006, in 2008 there is a 15% increase in the price in dollars due to the appreciation of the euro and underlying inflation of say 3% per year; together this means that the machine costs 22% more in dollar terms. The imports of raw materials for the construction industry face the same type of price increase.
Registrations of investors at BoI have declined sharply. The construction sector reports it is suffering from reduced demand. Domestic producers see slow down in domestic demands reducing the amount of investment needed to meet the market needs. Uniformly the economy faces declining weak aggregate demand for investment.1 The export impact on aggregate demand comes from the domestic content of the exports. In apparel sector there is a two way squeeze from lower price (C&M margins) and higher costs of imported materials. The export performance is only fair and the weakening world economy may adversely effect demand or alternatively drive down prices even further. Shrimp exports are slumping; other exports are doing moderately well. The export processing zone exports continue to increase exports rapidly, but this remains a small fraction of the total. A rough estimate suggests exports will expand the economy about 7% offsetting the decline from private investment. Other expansionary factors will contribute 1-2% to GDP. I forecast GDP growth of 2-4% in the current financial year. Those who are more optimistic about the near term growth rate claim private sector investment will recover strongly. We shall see. Will the inflation continue in double digits or will it be restrained? The inflation rate is now above 10% and the economy is likely to face continuing increases in food and raw material prices in taka terms. This is due to the continuing appreciation of the Indian rupee, the weakening balance of payments leading to a probable slight depreciation of the taka, and the world wide increase of prices in dollar terms. In addition, labour will be putting much pressure on the private sector to increase wages, transport costs are rising, and other input prices will face sharper price increases. Indian food prices are inflating at 3-5% and the rupee is appreciating with respect to the dollar at 7-10% per annum. The taka will depreciate with respect to the dollar by 4-6%. Thus food prices in Bangladesh will rise about 15-22% as most of these prices are linked to the Indian market. To the extent that smuggling is curtailed, the price increase in Bangladesh is likely to be even higher. Non-food prices will be pushed up due to higher transport costs and increases in the taka prices of imports due to both the depreciation of the taka and the dollar price increases. This suggests that price indexes will grow at 11-14%. In addition to these economic forces, the present policy of checking the market and looking for hoarders will contribute to higher inflation. At any time there is a minimum of 4-5 million metric tons of rice stored in Bangladesh. This is found in homes, farms, government warehouses, and within the trading system. Rice is moving around all the time in response to market requirements. If there is interference in these movements, then the rice being stored is going to be redistributed in ways that are inefficient, so it will tend to raise the price. The rice market is very competitive and while there are constant judgments of future prices and the best time to sell or buy, there is no scope for market manipulation. Government interference will cause prices to be higher than they otherwise would have been; while a short term decline may be achieved as rice is sold by traders: someone has to buy it. Households are unlikely to acquire a great deal more rice unless the price is sharply reduced, but this is not a sustainable policy. Lower prices following such a dumping of rice in the market will in turn be followed by higher prices. Disrupting the rice trading system is not a productive approach. Low domestic prices will discourage production. Waste in storage and movement will increase. Speculation will increase not decrease. Is the worst over? From the above comments it is clear that, in my opinion, the evidence points to continuing double digit inflation and continuing weak aggregate demand. There will be a return of confidence by the private sector when there is an elected government -- this confidence will rest on the belief that businessmen can do things that perhaps they should not but they will not fear major retribution. But fear will remain and the exuberance about the future that characterised the last three years of the alliance government will not return for some time. All the conferences, reassurances, pleas will not change things very rapidly. With the weakening world economy, I believe that export prospects are less promising than over the past five years. Now progress in exports will be achieved by raising productivity. But this is time consuming. It will take another two years to see a return to strong aggregate demand from private sector investment and exports. The caretaker government is establishing now the foundation of rapid growth, but it will take more time to achieve a new take off. Make much difference over the next two years? I argue that the main instruments of economic policy are not really available in the present configuration of forces. Monetary policy is ineffective as the problem with investment demand is neither the interest rates nor the availability of funds but fear of exposure to the ACC. Even though statements have been made that no one else will be investigated most businessmen will believe this only after a substantial time has passed and it is seen to be true. Elsewhere, I will discuss the recent Monetary Policy Statement and the macro-economic analysis that underlies its approach. The management of the exchange rate is particularly challenging since the weakening balance of payment can be supported by a foreign exchange reserve run down for sometime, but it is not clear if that is the right approach. Maintaining the exchange rate with respect to the dollar, waiting for the balance of payments position to correct, is a dangerous policy. For the next two years I believe that there will be little linkage between aggregate demand and monetary policy. Fiscal policy is even more difficult. The government deficit is already substantial. Reducing this deficit is an urgent task. But it is irresponsible to do so when the economy is growing slowly. These issues are long term ones -- improving the tax system, reducing subsidies, introducing user fees, reducing payments or subsidies to SOEs, privatisation, etc. None of these actions will do much good in the next two years but will have important consequence within 5 years. There are important policy actions needed in the financial sector, in agriculture, in the RMG sector and in energy, but none of these will have much impact over the next two years. The government could give the go ahead to a number of projects proposed by foreign investors; these projects would have little impact over the next two years but in the longer term they will add to production. Better to get started than to wait but do not expect much impact for the next 24 months. Is there enough food? This question troubles everyone. In my view the answer is yes. All of the data on supply of rice and wheat is based on some very dubious estimating procedures that have not been subject to recent implementation audit.2 Demand estimates are better.3 The size of the food gap is a mystery.4 But the solution to this policy dilemma is straightforward: the private sector be allowed to import as much rice or wheat as it wants; the private sector will react promptly to signals of rising prices and a shortage of rice or wheat within the economy. The government's responsibility is to ensure that the imported rice and wheat is of acceptable quality and to acquire grain through its procurement program by buying within the domestic market. The government's task is to operate a distribution system to poor households and to maintain a significant grain reserve. In conclusion, the Bangladesh economy faces two years of slow GDP growth and high inflation. There is little that macro-economic policy can do about this, as the causative factors are either external or are actions that have been already taken place and cannot be reversed. Selling low cost food to the poor particularly in rural areas and maintaining a competitive exchange rate are the two actions that government can achieve that will ease the pain through these two years. The real challenge to government is to continue the structural changes needed to allow rapid growth to emerge again. Forrest Cookson is an economist. Notes: |
