Arrows in the dark

Saturday, August 6th, 2011

Bangladesh Bank Governor Dr Atiur Rahman


Shayan S. Khan

The Bangladesh Bank released its half-yearly monetary policy statement on July 27, outlining two principal objectives- stemming the growth of credit in the economy, side by side with reining in runaway inflation. Economists however, immediately sounded their doubts on whether the policies outlined in the statement would succeed in achieving the twin objectives, particularly the one to do with inflation.


The statement noted that domestic credit growth of “well over” 25 percent was out of line with nominal GDP growth of 13.42 points, and therefore, Bangladesh Bank would take steps to stem the flow of credit to unproductive sectors.


“Bangladesh Bank will take further policy steps to discourage credit flows to unproductive and speculative uses,” the MPS says. The central bank plans to cut the consumer price index (CPI) inflation to 7.5 percent in the 12 months through June to meet the government’s target as set out in the budget for the current fiscal.


“Attaining the projected CPI decline will depend mainly on moderation of domestic food prices. These remain high and are rising under influence of global price trends,” the central bank policy statement said.


During the last fiscal, the planned private sector credit growth was fixed at 16.5 percent but it topped the ceiling by 9 percentage points to end at 25.5 percent. The central bank during the last fiscal increased repo and reverse repo rates by 225 basis points, and CRR by 50 basis points to contain the credit flow. The broad money target has been fixed at 18.5 percent with a calculation of growth rate of 7.0 percent, 7.5 percent inflation and 4.0 percent money velocity.


Economists said the central bank might not succeed in achieving its monetary policy targets for the current fiscal, due to the level of the government’s bank borrowing, as well as the “politicised” boards of state banks.


“Agri loans for motorcycles”


Adviser to the last caretaker government Mirza Azizul Islam, expressed doubts over the targets at a discussion organised by the Economic Reporters’ Forum in Dhaka on Saturday. The central bank announced the half-yearly monetary policy statement on Wednesday.


Mr Islam noted that the state-owned banks control about 50 percent of the bank credit. He said when he was an adviser in charge of the finance ministry, the state banks were given a corporate structure. As a result, the central bank got some control over those.


“In recent times, we have observed that the bank boards have been politicised. As a result, they are more or less out of control of the Bangladesh Bank,” Mr Islam said.


There is a limitation on the part of the central bank as to how much it can cut credit growth in the politicised banks, he said, adding that it remains to be seen what effect the credit growth creates as a result of giving loans in agriculture and small and medium enterprises.


As examples of credit growth in unproductive sectors, the former adviser pointed to loans taken for agricultural purpose being used for buying motorcycles, or building houses, or SME loans being invested in the stockmarket. Murshid Kuli Khan, deputy governor of the BB, however said the central bank strictly monitors agriculture loans and SME loans. The BB conducted a study which found that the loans have not been spent on other purposes, he said.


Subsequently, while talking to the Dhaka Courier over phone, Mr Islam said these are the “fundamental problems” of monetary policy, and for this reason, in recent times the targets set in the monetary policy could not be implemented. He, therefore, has doubts about how much of the objectives set out in the monetary policy statement could be achieved.


He also posed a question as to how prudent was the BB advice to borrow funds for large infrastructure projects from abroad.


Research Director of Bangladesh Institute of Development Studies (BIDS) Zaid Bakht said the BB monetary policy did not spell out how the target of cutting money supply would be achieved.


Mr Bakht said during the last fiscal, the banks invested heavily in the share market but the central bank did not take the right steps at the right time. They “awoke from slumber” in December and raised the cash reserve requirement (CRR), but the same trend exists now and it is not clear how much the BB will be able to contain it.


Mr Bakht also said public sector borrowing also pushes up inflation, but the monetary policy statement did not contain any message of caution with regards to government borrowing. He also noted that the biggest problem to do with government borrowing is that they borrow at the end of a fiscal year. As a result, when the commercial banks face a liquidity crisis they take money from the central bank. Ultimately, the entire amount of the government borrowing comes from the central bank, which increases inflation. World Bank senior economist Zahid Hussain said limiting the government borrowing will be a “big challenge”.


“The pressure of success”


BB Deputy Governor Ziaul Hasan Siddiqui refuted the criticism from Mr Bakht by saying that the central bank did not suddenly wake up in December to raise the CRR. He said inflation was increasing every month over the preceding six months, and that is why the central bank raised the CRR to control credit.


He also noted that the exposure of the banks in the capital market is only 3 percent of their liabilities. As per law, the banks can invest up to 10 percent of their liabilities in the stockmarket. Mr Siddiqui asserted that the MPS contained clear advice on the government’s and state owned enterprises’ borrowing.


Senior consultant of the BB Allah Malik Kazemi said, through the monetary policy the central bank succeeded in containing core inflation (non-food inflation). However, the MPS could not help contain food inflation. Mr Kazemi also said, as the economy sped up quickly in the last fiscal, the MPS had to make some concessions in line with the fiscal policy. He said he is hopeful of achieving the target set in the MPS for this fiscal year.


But Bangladesh Bank Governor Atiur Rahman brushed aside the worries and said the problems in the economy are due to the “pressure of success”.


“The rail tracks used for a train running at 50 kilometres an hour are now taking the burden of a train speeding at 150 kilometres,” he said. “It is creating some problems.”


The BB governor, however, said the problems will ease when higher growth is achieved. Replying to journalists’ queries about giving licence to new banks, the central bank governor said the decision to approve new banks will be taken following advice by the BB board. He also said the central bank enjoys full autonomy except in raising its staff salary. BB has set a target to lower credit growth to cut inflation. In the last fiscal year also, a target was fixed for cutting credit growth but it crossed the target.


Right targets, wrong arrows?


Monetary policy is a set of policy instruments used by the monetary authority in a country to control the supply of money in the economy, with the interest rate often playing the role of the principal instrument for implementing this policy. The official goals of monetary policy usually include relatively stable prices and low unemployment.


Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and a contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.


In the case of Bangladesh, the monetary policy lately has been said to be an “accommodative” one, as noted by economist Mamunur Rashid in a recent newspaper article, with the focus more on a balance between taming rampant inflation while at the same time supporting growth. Under such a policy, we may witness relatively quick shifts from expansionary to contractionary measures and vice-versa, to “fine-tune” growth in an economy prone to inflationary pressures.


But it is well known that developing countries may have problems establishing an effective operating monetary policy. The primary difficulty they face is that few developing countries have “deep markets” in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is perhaps the point Mirza Azizul Islam was touching upon when he said that from his experience, it would be “very difficult” to implement the MPS.


This is often because the monetary authority in a developing country is not independent of government, so good monetary policy takes a backseat to the political desires of the government or are used to pursue other non-monetary goals. It is for this and other reasons that developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarisation- the use of any foreign currency as the national currency. Although the situation in Bangladesh isn’t quite so drastic as yet as to warrant such extreme measures, such forms of monetary institutions essentially tie the hands of the government from interference and, it is hoped, that such policies will import the monetary policy of the anchor nation.


In recent times, some attempts at liberalising and reforming financial markets (particularly the recapitalisation of banks and other financial institutions in Nigeria and elsewhere, according to Wikipedia) are gradually providing the latitude required to implement monetary policy frameworks by the relevant central banks. It remains to be seen whether Bangladesh too can come out of the doldrums and make monetary policy work for itself, or whether the central bank’s initiative gets added to the long list of policy mishaps in the country’s history.

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