While the focus in Asia in recent months has shifted to inflation, there is a debate in Bangladesh over the conflicting figures of GDP growth. According to the Bangladesh Bureau of Statistics (BBS), the economy is projected to grow 6.7% in the fiscal year (FY) 2010-11. This provisional figure conflicts with other agencies that forecast 6.0 to 6.3% growth.
While the mismatch between actual and projected macro data is literally a norm, the debate over Bangladesh’s GDP growth has became a hot-button issue of late, when the Finance Minister vehemently dismissed the claim by the Centre for Policy Dialogue (CPD) that the actual growth was perhaps less than the figure projected by BBS.
The question is: Did the economy expand 6.7% in the outgoing fiscal year? In recent decades the highest growth was recorded in FY2006 when the country experienced 6.6% GDP growth. The jury is still out as all national account data is not yet available. But one can still speculate based on past trends of key macro variables. For instance, the economic growth rate is the ratio of investment (percentage of GDP) to incremental capital-output ratios (ICOR). In the recent past, the values of ICOR have been 3.91 (fiscal year or FY2008), 4.24 (FY2009) and 4.02 (FY2010) respectively. The decadal average is 4.17. In other words, the economy has to invest roughly 4.0% of GDP to increase 1% of economic growth. The investment rates have been largely stagnant for almost a decade, ranging from 23 to 24.7% of GDP.
According to BBS, the economy invested 24.7% (provisional figure) of GDP in the outgoing fiscal year. If we take the average ICOR (4.06) of the past three years, an investment rate of 27.2 is required to attain 6.7% growth in FY2011. If the investment does not go up an additional 2.5% of GDP in the revised investment figure (which seems unlikely), then ICOR has to be lowest (3.7) in recent decades to materialize the targeted growth.
The next point to ponder is if the economy has undergone any structural changes in the past year that increased efficiency in investment. Generally, investment efficiency is a positive function of infrastructure development, economic reform and participation of foreign investment, among other factors. Moreover, unutilized capacity in the previous fiscal year can augment the GDP in FY2011.
Anecdotally, in recent years the highest investment (24.7% of GDP) and lowest ICOR (3.7) in FY2006 were perhaps due to the post-Multi Fibre Agreement (MFA) structural changes in the country’s textile sector. This was reflected in lower ICOR values (averaged 3.8) in three successive years.
Some progress pertaining to agriculture mechanization, steady technological progresses in the apparel sector and increasing application of information technology (IT) in businesses in recent years might have increased some efficiency in investment. But the poor state of infrastructure, energy owe and low FDI may not lend support to the view that ICOR in FY2011 has been low enough to shore up record growth rate. Indeed, it has to be the lowest since 2005-06. Bangladesh has one of Asia’s poorest infrastructures and it is one of the least FDI recipient economies among key developing countries. Things have not changed much in these two areas for years to increase investment efficiency markedly bridging the actual and potential GDP growth gap. Indeed, infrastructure deficits keep mounting owing to the supply constraints.
That said, we have to wait until the actual national account data is available to see if the economy expanded 6.7% in the outgoing fiscal year. Nevertheless, it is not so much the issue of minor differences (0.1 to 0.5%) in actual and projected growth rates that worries the nation. Skyrocketing inflation is the major threat to the country’s economic stability and future growth potentials. Indeed, most central banks in Asia are cooling down their GDP growth to rein in inflation. Both China and India, Asia’s two fastest growing economies, forced to downgrade their growth forecasts due to inflationary pressure.
Apart from the economic cost of inflation, there is a severe political consequence of high inflation. Sitting governments often cannot beat the anti-incumbency in elections if there is high degree of inflation. While the distributive efficiency of growth is inconclusive (often helps the rich more than the poor), inflation hits the poorest hard. This is particularly true for countries like Bangladesh where food constitutes a large component of the consumption basket.
So, what is the inflation scenario of Bangladesh? The recent criticism heavily targeted the central bank for higher growth of high-powered money that believed to elevate prices. There might be some linkages between monetary expansion and asset price appreciation. However, the Bangladesh Bank can do little to rein in headline inflation.
Studies show that while monetary policy can be quite useful to contain core inflation, its role as far as headline inflation is concerned has proven to be less potent. Indeed, food and energy price hikes are fueling the overall inflation. Non-food inflation in the past 10 months has increased moderately vis-à-vis food inflation. A caveat here is some experts have found the moderate growth of non-food inflation is puzzling. Like GDP figure, some experts questioned about the reliability of BBS data on non-food inflation.
Bangladesh’s abysmally poor infrastructure also plays a critical role in augmenting inflation. A high degree of monetization (which is a sign of progress) is another factor behind price hikes. The size of the middle class has enlarged and the extreme poor’s entitlement to food has increased. Poverty has declined at a faster 2.0% rate a year on average since 2005. But there is a mismatch in income distribution that is making a large number of consumers (notably, urban low-wage earners and the fixed income group) worse off in terms of their purchasing power. The era of cheap food prices is perhaps over. The promise of keeping rice prices worth 10 tk per kg is the “original sin” of Awami League’s election manifesto that has become, albeit sarcastically, a yardstick of inflation!
While the central bank does not have any control over international commodity prices, the undervalued exchange rates (that benefits remitters and exporters) put pressure on prices – importers has to pass-through the imported inflation to consumers.
Whilst the recent contractionary monetary measures adopted by the central bank might contain the wheel of core inflation, the reversal trend in headline inflation will depends on a plethora of factors that includes the movement in international commodity prices, domestic food production, fiscal expenditures, remittances and other determinants of private consumption, projected GDP growth for the fiscal year 2011-12, among others.
Finally, let’s discuss the problems that are emanating from the country’s balance of payments (BoP). The fall of remittance growth, low margin in export earnings and high import cost owing to commodity price hikes are putting pressure on the balance of payment (BoP). Bangladesh’s terms of trade have rapidly deteriorated since 2008, largely owing to a sharp increase in oil and other commodity prices in the international markets. The export prices, for instance, increased 11.5%, whereas import prices shot up 27.5% in 2008. This adverse trend continues making terms of trade unfavorable for Bangladesh.
Consequently, after years of favorable position the country’s BoP is now under stress. The decline in the current account balance is alarming. The adverse development in the BoP (from US$2865 surplus in FY2009-10 to US$529 million deficits in July-March, 2010-11) largely owing to declining balances in current accounts, is an important policy lesson for the country’s policy makers. The neglect of the key components of financial accounts (mainly FDI, portfolio investment) made the economy over-reliant on export earnings and remittances, two key apparatus of current accounts. Had the successive governments adopted various policies to attract FDI and initiated reforms in financial markets (making the central bank a de facto independent institution), the country could have averted the problems that are originating from the BoP.
This new reality with existing fiscal deficits means increasing domestic and foreign debt that could shoot up interest rates, put pressure on exchange rates and increase inflation leading to slower economic growth. If commodity prices do not deflate markedly (oil prices may not drop much due to the uprisings in the Middle East) and remittance growth does not elevate substantially, the macroeconomic stability could face a severe test.
One may argue that most South Asian economies — India, Pakistan and Sri Lanka — have been running twin deficits (current account and budget deficits) for many years. But unlike India, Bangladesh does not have a sophisticated financial system that could channel external money to finance its saving-investment gap. Deficits in India’s current accounts are largely offset by surpluses in its financial and capital accounts. Pakistan’s and Sri Lanka’s twin deficits slowed down their growth significantly in the past few years (bar this year in Sri Lanka) and both have experienced a much higher level of inflation than that of Bangladesh.
While the import of short-term hot money (portfolio investment) is not feasible given the autarkic nature of the financial system, FDI could bridge the financing needs theoretically. This can only be done if a visionary government does the required reforms by easing the FDI rules, appointing the right personnel in the Board of Investment (BoI) and allowing a level-playing field for both foreign and local investors. Unfortunately, it cannot be done overnight.
Moreover, economics is also a function of politics. Given the deteriorating political scenarios in the country, the flow of foreign investment may not be adequate to offset the adverse developments in the BoP. The government seems to have little choice but to accept an IMF bailout.
Is austerity the way forward? Here comes the Finance Minister’s dilemma. Given the political reality, the Finance Minister may not be allowed to withdraw or minimize subsidies and other outlays. A recent surge in tax revenue may provide here a cushion. Nevertheless, IMF money may not be disbursed until the government agrees to accept some stringent conditions that are often difficult for the politicians to swallow.
To sum-up, the incessant rise of headline inflation, increasing pressure in BoP, existing fiscal imbalances and a potential bailout by the IMF may allow the policy makers very little choice but to accept the trade-off between inflation and growth. GDP growth of 6.0 to 6.5% with a 7 to 7.5% inflation target, maintaining macroeconomic stability, may perhaps be the right policy choices at this point in time.
This post originally appeared in Financial Express and is reproduced here with permission.
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