Spat over growth rate

In his budget speech the Minister of Finance has formally announced that the growth rate of the economy during 2010-11 will be 6.66 percent, the highest since the early '70s. It was not much in doubt that the economy will grow at 6 percent plus rate, but the announced rate appeared to be on the higher side. Some development partners had forecasted a growth rate of 6.2-6.3 percent, and many local economists and organisations such as CPD had been in broad agreement with them.

Ordinarily, small differences in the estimates of GDP, which in any case are imprecise (just compare the growth rate forecasts for various economies made by highly reputed international organisations), should not be a matter of great concern or debate. However, we do specialise in raising a storm in a tea cup and catapult non-issues into major concerns in our national life. The Finance Minister and the Economic Adviser chose to unleash a virulent attack on CPD for their intransigence in publicly expressing a doubt on the growth rate. Consequently, the issue has attracted some media attention.

It has been long suspected that the government has a tendency to overstate the GDP growth rate and understate the inflation rate. This suspicion will remain as long as Bangladesh Bureau of Statistics (BBS) remains hogtied preventing it to independently publish its findings. The outburst of the Minister of Agriculture against the BBS, whose findings did not quite corroborate her opinion about the achievements of her Ministry, is still fresh in public memory. As long as BBS requires political direction to publish its findings such suspicion will not go. The Minister is well advised to work toward independence of BBS from political interference if he wants to avoid suspicion about alleged BBS findings in future.

There is nothing outstanding or unusual about a growth rate of 6.66 percent. The economy had achieved a similar growth rate (6.63 percent) in 2005-06, and it certainly has the capacity to grow at a much faster rate. Nonetheless the announced growth rate appeared somewhat exaggerated to some probably because some related variables did not exhibit the expected co-movement.

There is a causal relationship between economic growth and real investment. Under some conditions, the economic growth rate is equal to the ratio of investment-output ratio and the incremental capital-output ratio. The latter is usually taken to be stable. Hence, economic growth depends directly on the investment-output ratio. An increase in economic growth rate occurs when investment-output ratio increases, usually by a multiple of the growth rate.

The data provided by the Ministry of Finance (Bangladesh Economic Review 2011) show that the economic growth rate increased from 6.07 to 6.66 percent between the last and the current fiscal year; i.e. an increase of 0.6 percent. Past data reveals that the capital-output ratio of the country is about 4 (see the table below). Hence, the investment ratio should have increased by 2.4 percent. But the investment ratio has actually increased by only 0.3 percent.  This perhaps provided a ground for the suspicion.

According to the formula above, 0.3 percent increase in the investment ratio could raise economic growth by 0.08 percent. Thus, such a small increase in investment ratio could raise the economic growth to only 6.15 percent. This is very close to the forecast of the development partners, but quite a bit removed from the figure announced by the Minister.

However, the estimates above are based on the assumption that the capital-output ratio is constant. If this ratio were to decline then the growth rate announced by the Minister is achievable even with the low investment ratio. Indeed, this is the argument advanced by the Governor of Bangladesh Bank in a recent speech. He said that productivity improvement enabled the country to produce more with the same amount of capital.

Productivity improvements usually occur over a period because of greater, and not less, use of capital. Nations that are highly productive (i.e. the developed countries) invariably use a great deal more capital than countries with low productivity (the poor countries).  Hence, it is unlikely that productivity improvements could lower capital-output ratio.

In the short term capital-output ratio usually moves counter-cyclically: during recession the ratio goes up and it falls during business booms. During the recession of 2008-09 the capital-output ratio of most countries increased, sometimes very substantially. Bangladesh also experienced a slight increase in the capital-output ratio during 2008-09 and 2009-10 when its growth rate declined. With a rebound of output the ratio declined in the current year. It will probably increase in the next fiscal year as the economy adjusts to the growth momentum.

The real issue of concern is the virtual stagnation of investment at a modest level during the last several years. Indeed the current investment ratio is the same as that achieved in 2005-06. Many people, including the Finance Minister and the Governor, have claimed on several occasions that there were positive indications of a substantial increase in business investment. They pointed to a surge in the import of capital machinery (as well as industrial raw materials) and a large increase in private credit as indicative of business enthusiasm.

During the July-April 2011 period fresh LC opening for capital machinery was higher than that of the same period last year by 60 percent, while settlement of LC (import payments) was higher by 43 percent. There were similar large increases in the LC settlements for machinery for miscellaneous industries and industrial raw materials. Private credit increased by 20 percent during the first nine months of the current fiscal year (on a year-on-year basis by over 29 percent). By any reckoning these are very impressive growth rates of the respective variables. However, we do not see the reflection of these large increases in capital imports and private credit on total investment which has remained stagnant.

This immediately raises the question if capital machinery import could be regarded as a reliable indicator of total investment of the nation. Total import payments for capital machinery comprise only a small part of the total investment. A large proportionate increase in such imports could be easily offset by a small proportionate reduction in investment elsewhere. It is also possible that imported items are not accurately categorised or investment not correctly estimated.

The question that should be a worry is what the large credit growth is financing if real investment is stagnant. It has now come to light that during the first half of the fiscal year a large part of domestic credit flowed into the share market. This flow provided the liquidity for the growth of the bubble that subsequently burst. It is not clear what has happened since then because the credit growth momentum is still not much diminished. Does the oft-cited spike in import explain the entire increase?

Table: Investment, growth and capital-output ratio of Bangladesh

* Forecast

Source: Bangladesh Economic Review 2011

The failure to correctly read the implications of a large growth of credit in an investment-shy environment was a major cause of the share market disaster. If the movements of important variables are not fully understood, the policymakers could lead the economy into another avoidable crisis.

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M A Taslim is a Professor of the Department of Economics, University of Dhaka