Although economic growth rate gets undue weight in ordinary discourse, economists usually describe the macroeconomic health of a country by a number of macroeconomic indicators. These include investment, (un)employment, inflation, budget deficit, national debt, balance of payments, and international reserves. For densely populated poor countries the poverty rate and inequality index should also be looked at. One of the reasons why all these indicators are regarded jointly important for the economic health of the country is that economic growth cannot be sustained for long if these other indicators are persistently moving in the wrong direction. Recovery also becomes tough if an adverse situation is allowed to continue for long. The sorry state of the economy of some developed countries such as Greece and Italy should be a stark reminder of the folly of letting these indicators get out of hand. Many developing countries had experienced a similar situation in the past.
To go by government statistics Bangladesh achieved the highest ever growth rate of 6.7 percent during the last fiscal year (2010-11). This was made possible largely by a booming export sector and robust growth of agriculture and remittances. The high economic growth permitted the per capita income to increase by more than 5 percent, no mean achievement in our situation. What is worrisome though is that the high growth was not accompanied by a robust performance of any of the other indicators raising concerns whether an economic crisis is in the making.
Investment is the principal determinant of growth. Unfortunately, statistics on investment are hard to get by, and the quality of whatever data are available is doubtful. BBS publishes aggregative data on investment and saving on an annual basis with a lag of about a year. These are not very useful for short-term policymaking or for forecasts. Hence, researchers have been forced to rely on proxy variables that are more readily available to guess about investment spending. Some of these variables are domestic credit growth especially that to the private sector and imports of capital machinery and industrial raw materials.
Total credit has declined from 4.8 percent during the first quarter of 2010-11 to 3.8 percent during the same period of the current fiscal (Bangladesh Bank, Selected Indicators, 10 Nov 2011). However, credit to the government increased from –1.4 percent to a whopping 9.4 percent during the same interval. Such a large increase was achieved by crowding out private credit whose growth fell from a robust 6.1 percent to only 2.8 percent. It is possible that the large reduction in private credit was caused also by a fall in investment demand due to a loss of business confidence, inadequate power supply and a gloomy domestic and international economic outlook.
A worrisome development is the drastic fall in capital import demand; LC openings have fallen by 37.3 percent during the first quarter of 2011-12 when the same had increased by 101.6 percent during the first quarter of 2010-11, and by 40.2 percent during the entire fiscal year 2010-11. The decline is perhaps due partly to a reduction in the import of power generation equipment that has not been compensated by an increase in import demand of other capital machinery. Significantly, there has also been a reduction in the demand for textile and garments machinery indicating a cautious approach of these leading export sectors regarding their future outlook. Overall, capital investment demand seems to have declined. The government needs to take urgent steps to raise total investment as it is the key to growth. It can do so by increasing productive public investment, especially in physical and social infrastructure and by instituting appropriate policy changes to encourage private investment, both domestic and green field foreign investment. Given that a large budget deficit is building up, the government would be well advised to do more of the latter and less of the former. An improvement in the overall business climate is essential to achieve such an outcome. The government should choose an optimal investment strategy that ensures the highest impact on economic growth and employment in the long term.
Import of industrial raw materials has also declined markedly. The growth of LC openings has declined from a robust 46 percent during the first quarter of the last fiscal to a modest 18.5 percent during the same quarter of the current fiscal, while the growth of LC settlement has fallen from 41.9 percent to only 15.6 percent. This would suggest a slowdown in industrial activities, which cannot be verified due to a lack of data.
All these numbers, taken together with the high inflation environment, rising capital costs, political instability and the global economic crisis especially in our major export markets would suggest a significant downturn in private investment. If this situation does not reverse soon economic growth will be a casualty. This is an opportune time for the digital government to come up with a vision to beat the gloom and deliver.
There is no reliable data on unemployment, principally because extreme poverty and the absence of unemployment benefits force everyone into some income-earning activities. Consequently the main manifestation of a lack of employment opportunities is underemployment, rather than outright unemployment. This is reflected in the enormous number of young people that apply for any reasonable employment opportunities and the very low productivity work that a substantial fraction of the labour force is engaged in. Some economists suggest that the underemployment rate could be well in excess of 40 percent of the labour force. But the Finance Minister did not even mention underemployment in his budget speech of 2011-12, and he puts the unemployment figure at a meagre 2.5 million (curiously the same figure is mentioned as the total of unemployment and underemployment in his speech at the World Bank head office in September). If this were the true unemployment rate then there would be little reason to worry about unemployment since the natural rate of unemployment is likely to be much above this rate! The poor quality of statistics forces researchers to rely on casual empiricism or proxy variables to guess about the true extent of unemployment in the economy.
Employment depends on the growth rate of the economy – a higher growth rate promotes greater employment. Since about 1.5 million new faces are added to the labour force every year due to population growth, the economic growth rate has to be very high in order to make a dent on unemployment. Economic growth depends on the investment-GDP ratio; a higher growth can be achieved only if there is a commensurate increase in this ratio. However, the ratio has not increased since 2005-06. Hence, the rate of employment generation is unlikely to have increased. Some government spokespersons have attributed last year’s high economic growth rate (despite limited investment) to a substantial increase in productivity. It is not clear what the source of this increase in productivity was. But the net effect seems to have been a jobless growth of the economy. An implication of this is that an ever increasing number of people are being forced into outright unemployment, or low productivity informal work that swells the rank of the underemployed.
A matter of serious concern is the inflationary spiral that seems to have taken hold of the economy. Inflation has been creeping up steadily from its low level at the beginning of the millennium till the last quarter of 2008. This has been in the main due to a steady increase in domestic food prices. A large fraction of the demand for cereals, spices, sugar and edible oil is met by imports, and the country exports fish and vegetables. Consequently, their prices are closely linked to international prices. There was a world-wide increase in fuel and food prices during 2001-08: food price index increased by 2.4 times, grain by 2.8 times, fats and oils by 2.9 times and energy by 3.8 times. Such large increases in the prices quickly fed into domestic prices. There was very little that the monetary authorities could do to limit price increases from this source. Only fiscal actions, if properly designed and executed, might have had moderated the price hike. That the inflation was largely imported was underlined by the fact that it fell abruptly from around the mid-2008 due a collapse of the international commodity prices. As the international market rebounded, domestic inflation commenced its upward march from 2010 onward.
However, the monetary authorities seem to have played an active part, not just accommodative, in the acceleration of price increases during the last two years. The chart below shows an unmistakable rising tendency of the money supply; the growth rate of broad money increased steadily from 17.6 percent in 2007-08 to 19.2 in 2008-09, 22.4 percent in 2009-10 and 21.3 percent in 2010-11. Considering the fact that the inflation rate was fairly low during 2009, the large increase in money supply must have contributed to the large increase in the prices, especially that of non-food and non-traded items, by increasing the aggregate demand of the economy. The chart shows that the acceleration in monetary growth was accompanied by an increase in average CPI inflation. The price inflation could have been more severe but for the fact that a large part of the increased money supply found way to the share market which contributed to a very large increase in the stock prices by artificially boosting up capital market demand.
The steady increase in domestic prices over a fairly long period of time (albeit with a hiatus in 2009) appears to have engendered expectations of price increases. These were further strengthened by the rapid increase in the money supply over the last two years or so. The repeated failure of Bangladesh Bank to adhere to the pre-announced monetary targets during the past several years made a mockery of its inflation-targeting policy, and helped entrench inflation expectations. It will be difficult to break the cycle without very tough measures.
It is rather too well-known that a large increase in money supply will eventually lead to inflation. Why did Bangladesh Bank repeatedly increase the money supply far beyond the target set by itself?
In theory the central bank controls the money supply, or has the means to control it. In practice its hands are often forced by circumstances, especially so if it is not much more than an extended arm of the Ministry of Finance. For example, the Board of the Bangladesh Bank had unequivocally said that the economy did not need any more banks at this time; but had to quickly change its stand when the Ministry insisted that the establishment of new banks was a political decision.
During the calendar year 2009, the increase in money supply was largely the consequence of the substantial balance of payments surpluses. The policy decision of preventing the exchange rate from appreciating resulted in a large increase in the net foreign assets of BB. It sterilised only part of this increase by reducing its holdings of domestic assets. However, the emerging balance of payments problems meant that there was only a very small increase in the net foreign assets of BB in 2010. This was more than compensated by a very large increase in the domestic assets which maintained the high monetary growth. The growth rates of monetary reserves and broad money during the first two months of 2011-12 were considerably higher than that during the corresponding period last year suggesting a strong likelihood of continued high monetary growth.
The large growth in the domestic asset holdings of BB was a direct consequence of the budget deficit incurred by the government and borrowing by the commercial banks from BB. The latter did not show any increase from 2005 to October 2010 remaining at about Tk61 billion. But within the following two months it had nearly doubled and by June 2011 it had trebled. The government that had nearly halved its net credit from BB between June 2007 and December 2009 went on a borrowing spree since then. By the end of the fiscal year 2009-10, it had increased its net borrowings by two-thirds, and by the end of 2010-11, its borrowings had increased by another three-fifths. Thus, the Government’s net credit from BB had increased by 2.4 times within 18 months. Since there was no offsetting reduction in the net foreign assets of BB, the entire increase in net government credit went to raising the reserve money holdings of BB, which in turn caused a corresponding multiple increase in the money supply. If government borrowing from BB continues unabated, the money supply will continue increasing. Hence, the prospect of a substantial improvement on the inflation front in the near future seems slim.
When inflation expectations become embedded, a substantial reduction in monetary growth will not have much immediate effect. It may take 12-18 months before a monetary contraction is reflected in price reductions. It would thus seem that the economy will suffer from inflation for at least a couple of years even if corrective actions are taken within a short time. The high inflation could dampen the growth momentum of the economy.
M A Taslim is a professor of the Department of Economics, University of Dhaka.