When Covid-19 led to the recession of 2020, governments across the world, led by advanced economies, implemented fiscal stimulus packages, monetary policy accommodation, as well as labour market and social protection policies. At its peak, advanced economies provided direct fiscal support equivalent to 17% of GDP. Low- and middle-income economies, including Bangladesh, did much less, but the direction of fiscal policy was unambiguously expansionary.
In the realm of monetary policy, central banks in systemically important countries reduced policy rates, often to zero, and in some cases, these rates became negative. This was typically combined with large-scale quantitative easing. Central banks in the developing world followed suit and took the historically unprecedented step of significantly reducing policy rates.
At least partly because of these fiscal and monetary policy actions, the 2020 recession was short-lived. Now, however, the macroeconomic policy discourse has changed quite radically. Faced with a surge in inflation, and concerns about debt sustainability, especially in emerging economies, both central banks and fiscal authorities have shifted to monetary and fiscal policy tightening at a time when there is considerable evidence of a global growth slow-down, reflecting a reduced growth momentum across major regions of the world.
For example, in emerging and developing economies, estimated and projected growth for 2020-2027 is significantly lower (3.7%) than 2009-2019 (4.8%). The decline in the growth momentum over the two periods in two of the world's most populous economies (China and India) is conspicuous – see Figure 1.
Source: Derived from IMF data mapper.
Admittedly, inflation has surged across the world and reached a double-digit threshold in many cases. The IMF contends that about 60% of low-income economies are in debt distress, although the comparative figure is much less in middle-income economies (25%). Hence, taming inflation and staving off the risk of national debt defaults are the right policy priorities.
On the other hand, a basic premise of elementary macroeconomics is that simultaneously tightening fiscal and monetary policy during an incipient downturn will only worsen the downturn. Hence, a legitimate question to ask is: Are national governments, especially in the advanced economies, overdoing restrictive monetary policy and engaging in premature fiscal austerity programs? Furthermore, given that developing countries like Bangladesh often follow the direction and pace set by advanced economies, what happens 'there' has enormous implications 'here'.
Resolving the nature of the trade-offs embedded in the current macroeconomic policy decisions of the advanced economies entails a dissection of the sources of inflation in the world today. If inflation is demand-driven, then it makes sense to use monetary policy instruments to tame inflation. The release of pent-up demand following the normalisation of pandemic-related restrictive measures played a role in pushing up prices, but Covid-19 also caused major bottlenecks by disrupting global supply chains.
Russia's invasion of Ukraine that commenced in February 2022, as well as stringent sanctions imposed on Russia by the US and its allies, have led to a sharp increase in food and energy prices. In circumstances where supply-side forces are also important in driving inflation, tightening monetary policy can impose painful consequences. Inflation can be reduced but at the expense of lower growth, constrained employment opportunities and even downright recession.
Considering this global context, what is the appropriate policy response by the Bangladesh government? Should it follow the lead set by the advanced economies uncritically by implementing significantly restrictive macroeconomic policies? Or should it strive to seek a more independent path that is mindful of its specific national circumstances?
The Bangladesh Government, in common with other countries, has been preoccupied with controlling inflation using a contractionary monetary policy. This may impose twofold risks to the economy if it is not complemented by appropriate coordination, institutional capacities, and additional supportive policies. First, controlling inflation by uncritically following the developed country's norm of focusing on changes to the policy rate might not be effective in tempering inflation, given that such an approach works well in the institutional environment of an advanced economy, not necessarily in the conditions of a middle economy with a large informal sector. Second, it can induce high risks to economic growth and employment.
From July to October 2022, the Bangladesh Bank increased the policy or 'repo rate' (the rate at which commercial banks must pay to the central bank to borrow money) three times to reduce the pressure of inflation. The intention was to make the increased repo rate an instrument to allow the central bank to control liquidity and investment in the economy. Unfortunately, right after the repo rate hike, the credit growth in the private sector shot up to almost 14% in July 2022, this being the highest since 2018.
It is crucial to understand that the Bangladesh Bank maintained the cap of a 9% interest rate for loans. If instead, the interest rate for loans was set at 13-15%, for instance, then the cost of borrowing for businesses would have increased, resulting in a cost reduction mechanism adopted by the businesses community. This would have led towards a reduced burden of prices towards consumers. But, in contrast, businesses are availing credit at a low cost due to the current policy measures of the Bangladesh Bank. If Bangladesh Bank does not increase the loan interest rate coupled with the increased repo rate, the ambition of controlling credit is likely to fail.
Figure 2 depicts the sharply increasing inflation rate in 2022, though in October 2022, the inflation rate came down to 8.91% from 9.10% in September. The inflation rate was the highest in 10 years, equivalent to 9.52% in August 2022. The policy tools and interventions taken so far by the government to control inflation have had limited impact.
Source: Derived from Bangladesh Bureau of Statistics, 2022.
Now, the question is how Bangladesh can assess the local context critically and make use of a combination of global tools and local solutions. To answer this, we would like to focus on two key issues. First, are we measuring inflation correctly? Bangladesh Bureau of Statistics (BBS) is calculating today's inflation using 2004-2005 as the baseline year, which surely does not reflect the reality of commodity baskets and prices of 2022. Second, are we identifying the root causes of the increasing inflation rate in Bangladesh?
The prime reasons for the increasing inflation rate in Bangladesh are the increase in food prices and prices of daily consumption commodities that are mostly imported, distortion in domestic and global supply chains, rising fuel prices, depreciation of taka (with respect to USD), unregulated business interests and firms' oligopolistic market power for making supply shortages and weak institutional capacities to monitor and regulate the market.
Therefore, a contractionary monetary policy without the support of policy interventions such as lowering import prices of food and regular consumption goods, supporting supply chains, strengthening institutional monitoring, and enforcing regulations to reduce oligopolistic practices is unlikely to be effective in tackling inflation. In addition, an obsession with controlling inflation may encourage the policymakers of Bangladesh to trade off higher joblessness with curbing inflation with an expectation that the newly unemployed households typically cut back on spending.
In a country such as Bangladesh, where labour market institutions manifested in employment protection legislation, minimum wage, and unemployment benefits, are not effective, employers may find it easy to engage in layoffs and comply with the government policies of controlling inflation. Employers can control the capacity of workers to bargain for higher wages through large-scale layoffs and thus flatten wage growth. Once the wage growth flattens, firms can continue operations without asking for higher prices. Hence, inflation can be tempered by increasing unemployment and flattening wage growth.
Finally, as Bangladesh is expected to graduate from LDC status by 2026, it is crucial for the country to encourage increased private investment and increase the aggregate demand of the country for sustaining higher and more resilient economic growth. With a tightening of the monetary policy to control inflation, both consumption and investment spending will decline in the absence of supportive fiscal policy, which will result in lower aggregate demand for goods and services in the economy.
This is indeed the biggest threat for Bangladesh if it is preoccupied with taming inflation right after facing the economic slowdown and job losses due to Covid-19. Therefore, in the upcoming years, to stay internationally competitive, diversify manufacturing, increase private sector investment, and create jobs, Bangladesh needs a coordinated policy approach inspired by global practices but adapted to local realities.
*The analysis of this article does not represent any organisational views and perspectives rather it's the opinion of the authors.
Md. Nazmul Avi Hossain is an Economist currently working at the ILO
Dr. Iyanatul Islam is a visiting Professor at Griffith University, Australia. He is a former branch chief of the Employment and Labour Market Policy Branch at the ILO Headquarters in Geneva.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.