Unanswered questions in MPS

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Bangladesh Bank (BB) issued Monetary Policy Statement (MPS) for the second half of the current fiscal year on January 30. This is the eleventh issue of MPS. I welcome the continuation of the practice primarily because such ex-ante announcements have the potential of providing a basis for expectations by various market actors. However, as in the past, the present MPS also leaves many questions unanswered. This article seeks to raise some of them with a view to drawing BB's attention in drafting future statements.
Gap between targets and achievements in the recent past
The first set of questions relates to the effectiveness of MPS in fulfilling the targets relating to monetary aggregates. The following table illustrates wide divergence between the programmed targets and the actual outturns.
Of particular interest in the above table is the private sector credit component over which Bangladesh Bank, in principle, should be able to exercise the greatest control. Yet, this component has overshot the programmed target by a very wide margin. MPS January-June 2011 provide no explanation for this unwelcome eventuality. The questions that arise in light of the above are the following:
* Was the divergence caused by lack of appropriate instruments at the disposal of BB?
* If BB possesses the necessary instruments, why weren't those used?
* Does the divergence indicate monitoring and supervision failure on the part of BB?
Appropriateness and likelihood of achieving January-June 2011 targets
In the above context, it may be recalled that in an earlier paper (DS September 14, 2010) I argued that conventional instruments available at the disposal of the central bank -- variations in cash reserve/statutory liquidity requirements and operations in treasurery bonds -- cannot exert significant influence on money supply in presence of large excess liquidity typically maintained by commercial banks in Bangladesh. The divergences noted above provide eloquent credence to this view.
As on end December 2010, the scheduled banks had an excess liquidity of Tk.23,721 crores. This amount is considerably lower than on end-May 2010 when it was about Tk.31,000 crores, but large enough to frustrate BB's efforts to restrain the growth of monetary aggregates. Taking into consideration the continuing high level of excess liquidity and the dismal experience in the recent past, the pertinent questions are:
* How would Bangladesh Bank ensure that June 11 targets will be fulfilled?
* Has BB divised any new instruments to ensure convergence between the targets and actual outturns?
The above questions are particularly relevant because BB adopted a number of measures in the later part of 2010 to contain the growth of monetary aggregates with no perceptible impact. The measures included tightening of compliance surveillance on permitted ceiling of holding of capital market assets in June 2010, doubling of general provisioning requirement on bank loans against stocks and shares to 2% in October 2010, half percentage point increase in cash reserve requirement and statutory liquidity requirement from mid-May 2010 and one percentage point increase in BB's overnight repo and reverse repo interest rates. Yet, data on monetary aggregates for November 2010 fail to demonstrate desired results.
Year-on-Year growth in all the components of monetary aggregates (except credit to the public sector) as of November 2010 was way above the levels programmed for June 11 as announced in July-December 2010 MPS. Despite these developments, identical targets have been retained in January-June 2011 MPS. Hence the appropriateness of targets is open to question.
Objectivity of growth and inflation outlook
MPS January-June 2011 states "Bangladesh economy looks well poised to attain the 6.7% real GDP growth targeted by government for FY 11, and well on course for growth exceeding 7% in real terms in FY 12." The statement is based on assessment of positive overall external sector outlook, healthy agricultural output growth and continuing recovery in manufacturing output responding to robust domestic demand coupled with easing of power supply shortages as new rental plants start generation. The arguments are sensible prima facie, but there are serious caveats that BB seems to have ignored.
First, astounding export growth of 41% during July-December 2010 provides the basis for the assessment of external sector outlook. However, it should be remembered that what contributes to GDP is not exports per se, but the balance of exports minus imports. During July-November 2010, deficit in trade balance increased by nearly 40% compared to the same period of last year, remittance growth turned negative, overall current account surplus fell drastically to $563 million from $1,674 million and there was a drastic reduction in aid disbursement as reflected in net foreign financing of government budget declining from Tk.6,832 crores to Tk.2,108 crores.
Second, the decrease in the index of small scale manufacturing output by over 9% does not portray a rosy picture. Third, any additional generation of electricity by quick rental plants has to be set off against likely fall in actual generation from the old plants because of breakdowns caused by poor maintenance and shortage of gas supply. Fourth, disincentive for new investments due to continuing suspension of new gas and electricity connections is unlikely to be alleviated during the remainder of the current fiscal year.
On balance, the expectation that the growth rate in the current fiscal year will exceed that of last year by nearly 1% is unlikely to materialise.
As regards inflation, MPS (January-June 2011) states: "Subject to current low non-food inflation not being stoked up by demand shock from excessive credit expansion, the 12-month average domestic CPI inflation is still expected to keep easing down … to a level around 7% by June 2011." BB rightly acknowledges that monetary policy actions will have little coverage on rising food prices. The notion that the upside of food price inflation in the remainder of the current fiscal year will be contained by reportedly large global grain stocks is not supported by any forecasts emanating from the international community.
Non-food inflation is likely to get cost-push boost not merely from domestic increase in electricity price but also from increase in the international price of petroleum leading to higher prices of imported raw materials and intermediate goods as well as depreciating exchange rate. The first half of the current fiscal year has already witnessed six-monthly average inflation of 7.5%. In light of the above factors it can be reasonably estimated that the current fiscal year will end with an inflation rate of about 8%.

The writer is a former adviser to the previous caretaker government.