Off the mark: This is how you run the economy

Published : 1 May 2012, 10:45 AM
Updated : 1 May 2012, 10:45 AM

The Finance Minster (FM) often says things that surprise the economics profession. Perhaps that is only because they are paying attention to the wrong things. When the FM speaks to the local media or even to his parliamentary colleagues he is essentially talking politics. And politics of our country has already degenerated sufficiently not to necessarily have substance. However, when the FM writes memos to the IMF supplicating for funds, he has to talk economics, with facts and figures to boot. Hence, if one is interested in knowing what the FM really thinks about the state of the economy, he should read the memo that he has written to the IMF in a desperate bid to have the Extended Credit Facility (ECF) fund released. We must thank the IMF that it published the memo and the attachments on its website. Otherwise the nation would have been in the dark about the full contents of the FM's communication. The IMF does some good things too!

The FM states at the beginning of the Memorandum of Economic and Financial Policies: "Macroeconomic pressures have intensified over the past 18 months resulting in heightened risks to Bangladesh's external position". He apparently now recognises the build-up of macroeconomic pressures and its balance of payments consequences which the local economists repeatedly warned him about during the past year or so, and which he initially rejected. He also states "…fiscal pressures have also emerged, stemming mainly from rising fuel, electricity and fertilizer subsidies. In turn, domestic borrowing by the government rose sharply in the first half of FY12, straining available liquidity in the banking system and putting upward pressure on interest rates".

This confession of sorts is in sharp contrast to the government's obdurate reluctance to admit that the oil-driven rental power plants have thrown fiscal discipline out of the window and that government borrowing has crowded out the private sector. These gas-guzzling plants have increased petroleum imports by more than three billion dollars punching a big hole in the balance of payments. This was further aggravated by foreign relations debacles that have dried up external funds. There has been very little net inflow of foreign resources during this fiscal year. A consequence of this has been the depreciation of the taka.

The onset of an economic downturn worldwide, especially in our main export markets, has considerably slowed down the growth of exports which has largely offset the effects of BB's recessive policies to contain imports through aggregate demand management. Large scale government borrowing at a time of tight monetary policy has caused a liquidity crunch that has pushed the interest rate much higher than intended. Investment has taken a hit dimming the prospect of high growth and new employment.

To get out of the current predicament the government had to agree to the harsh conditionalties of the ECF. These will drag the economy further down before any improvement becomes visible, i.e. things will get worse before it becomes better.   This is underscored by the IMF's forecast of a growth rate of only 5.5 per cent this fiscal year. This is a far cry from the FM's insistence that 7 per cent growth target will be achieved, but conforms to the apprehension of the local economists that it would be difficult to achieve even 6 per cent growth this year.

In the cleverly designed package agreed with the IMF ceilings or floors have been set on only a few variables. The government had to commit not to exceed the agreed ceilings on net domestic assets of Bangladesh Bank (BB), net credit to the government by the banking system, non-concessional external debt and suppliers' credit and reserve money. It also agreed to maintain net international reserves, tax revenues and social spending above the suggested floors.

These apparently innocuous conditionalities actually put restrictions on the flexibility of the government in deciding on the nature and magnitude of the current and the next budget. Taken together these essentially impose limits on the extent of government spending and borrowing, and ensure that the current tight monetary policy is continued. Hence, the government's policy space is circumscribed in an essential way. The elected government that boasts of nine-tenths majority in the parliament has effectively surrendered its flexibility to conduct national fiscal and monetary policies in a manner that will achieve the goals of its much-touted manifesto; some people from overseas will now oversee the economic policies of the sovereign government.

The impact of the conditionalities on the monetary sector is already evident from the rising interest rates and falling credit growth. Fiscal discipline will be imposed through the ceilings on net credit to the government and non-concessional foreign borrowing. Subsidies will be reduced by increasing electricity tariffs which have already increased by about 40 per cent. An automatic adjustment mechanism will be put into effect by the year-end to ensure full pass-through of international fuel prices to domestic prices. Thus the subsidy costs will be shifted to the public. Tax effort will be intensified to increase revenue. The Ministry has indicated a budget size of Tk1.89 trillion for the next fiscal year. If the inflation rate remains at its current level, this will represents only a very small real increase over this year's budget. Fiscal policy will be, therefore, restrictive to match the restrained monetary policy.

While such imposed restrictions may seem abhorrent to some independent-minded people, the shrinking of the policy space of the government may not be an altogether bad thing. The manner in which the government has turned a fairly good economic situation (of 2009-2010) to its current depressing state calls its economic management credentials into question. On its own it might have pushed the economy into a crisis zone. The external intervention might help to put the economy on track.  Since no one in the government or the party seems to be much concerned about being told how to run the economy, there should not be much internal resistance. The silver lining is that if these policies work, the government could claim credit in time for the next election.

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M. A. Taslim is a Professor of Economics of the Department of Economics, University of Dhaka. He is currently holding the charge of the Chairman of the Department. He was formerly the Chairman of Bangladesh Tariff Commission.