Creeping inflation in Bangladesh

In recent months, I have written several opinion pieces on the various aspects of inflation in Bangladesh. Inflationary pressure has been increasing again in recent months. The latest figure shows a 7.41 percent inflation in November. Fuel import, energy price hike and Taka's devaluation against the US dollar have combined to increase Bangladesh's non-food inflation. Food inflation has also increased, although not by the same amount.

The country's general inflation has also been in double digits for some time now. The last time it happened was in the early 1980s. In addition to price hike of electricity and fuel oils, and devaluation of taka, the rise in government's spending and credit growth in both public and private sectors have also contributed to the rise in inflation.

Prices of a number of essential food commodities have also increased in recent months. However, it should be noted that the Ministry of Food has taken a number of positive steps which has kept the price increases from going out of control. However, despite the best of intention of the Ministry of Food, the retail prices of food grains in the local market have increased significantly in recent months and are likely to increase further until the next harvest. This raises concerns about economic stability and food insecurity as the purchasing power of low-income families has been reduced.

Last year, the International Monetary Fund (IMF) had asked the Bangladesh Bank to tighten monetary policy to contain inflation. The IMF recommended, among other measures, safeguarding reserves through continued exchange rate flexibility and interventions only to smooth short-term volatility, and addressing financial sector vulnerabilities by strengthening and enforcing bank supervisory framework and market oversight and ensuring sound governance.

Over the last few months, the Bangladesh Bank has followed a restrictive monetary policy by raising rates on a number of occasions. The Bank has also increased statutory liquidity ratio and cash reserve requirement in an effort to keep inflation in check.

However, the problem with such an effort is that these policy measures would be adequate if only excess demand were driving inflation. Inflation caused by changes on the supply side of the market would remain mostly unaffected by the policies recommended by the IMF and undertaken by the Bangladesh Bank.

A look at the causes of inflation would show that in recent months changes the supply side has been as much of a factor in raising the inflation rate as changes in the demand side. In short, inflation in Bangladesh has been both a cost-push and a demand-pull phenomena.

Inflation in Bangladesh has historically moved proportionately with food prices. The weight of food items in the consumer price index (CPI) is more than 55%. In recent months, not only food prices increased in the international market, the prices of fuel, seeds, fertilisers, labour wages, insecticides and transport cost also went up, leading to higher costs in domestic food production.

The major macroeconomic variables, such as, revenue, expenditure and balance of payment position were also badly affected by the higher prices of food items. The overall trade deficit increased significantly.

Rapid increase in the prices of food items eroded the purchasing power as well as standard of living of the poor, government and non-government employees, industrial workers, the unemployed and the people with limited income. This has forced a section of the population to drop below the poverty line.

Confronted with inflationary pressures, increasing poverty and social unrest, the government has introduced beggar-thy-neighbour policies that has reduced the nation's welfare and undermined a rules-based trading system. This has drawn substantial criticism from multilateral organisations like the World Bank and the IMF. Rather than trying to insulate domestic prices they have argued that the government should let prices adjust to reflect the change in international prices and use targeted safety nets to compensate the poor.

Suppose the Bangladesh government accepts the conventional wisdom and focuses on ways to protect the poor from the impact of higher domestic food prices. Is the government ready? In particular, do safety net programmes exist, and can they be easily expanded? Does the government have the fiscal space to accommodate the additional resources needed to fund the safety net?

Unfortunately, the answer to each of these questions is a resounding "no."

Safety nets for the affected population in Bangladesh are inadequate. This is despite a number of successful steps taken by the Ministry of Food. So if safety nets are to be used in future episodes of rising food prices, they need to be put in place now. In particular, multilateral organisations should work with the government to implement cash transfer programmes so that the poor can quickly and efficiently be compensated for the loss in purchasing power when food prices rise. In addition, the government should have mechanisms in place to ensure that when cash transfers need to be expanded, they will have the required fiscal resources.

Our food grain stock management could also be improved in order to tackle inflation. Due to inadequate storage capacity and technology, high stocks have led to high wastage. The increase in procurement in recent months has also led to a significant increase in the fiscal costs of the system. Further, inefficiencies in the system not only lead to high losses of the grains it handles, they also drive up the costs of food handling.

The government would also need to cope with the social discontent among urban households who are not poor enough to be included in the safety net programmes but are hurt by higher food prices. In the past, this has tempted the government to insulate domestic prices with beggar-thy-neighbour administrative measures.

By exclusively depending on tight monetary policy, the Bangladesh Bank may have a dampening effect on economic activity as the recessionary impact of such a policy might reduce the fiscal resources available to compensate the poor through targeted safety nets. Thus an over-arching coordinated policy is required in order to tackle the rising inflationary trend.

The current government has taken a number of positive steps in keeping food prices as well as general non-food prices under control. These measures need to be further sharpened and enforced in order to close the policy loopholes that still exist. This will help to keep the overall inflationary environment in the country under control.

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A. R. Chowdhury is the Chairman of the Department of Economics at Marquette University. He also serves as the Chief Economist for the Capital Market Consultants and was recently appointed to the Academic Advisory Council of the Chicago Federal Reserve Bank.