How can Bangladesh Bank counter high oil prices?

A convoy of rebel fighters drives past a sign welcoming guests at the entrance of the Brega university on the edge of the key oil city in Libya. The Middle East crisis stoked fears of an oil price hike around the world. Photo: AFP

It has been close to 3 months and the Middle East crisis continues to hit headlines across the world. Some call it the Arab world uprising and some call it the Arab youthquake. But whatever name we may use, the repressive governments in the region are surely having a tough time in controlling the boiling tempest.
Two presidents have already conceded to the public outcry and many more heads are expected to get toppled in the next few months. Libya, Syria and Yemen seem to have dark clouds hanging over their president's future, while on the other hand, Arab monarchs in Saudi Arabia and Bahrain are shelling out fresh incentives from their very deep caskets to silence the democratic demands.
As if the Middle East crisis was not enough to stifle world recovery, Japan was hit with a devastating 8.9 magnitude earthquake and tsunami, killing more than 12,000 people. Immediately following the earthquake, Japan's Fukushima nuclear power plants reported a failure in their cooling system as several nuclear plants were shutdown, resulting in severe electricity shortages across the country. Japan's Prime Minister Naoto Kan quickly ordered the state machinery to release 66 million barrels of oil to meet up the deficiency of nuclear energy.
The twin crisis in the Middle East and Japan are already pushing oil prices up as Brent oil reached a peak of $119 a barrel some days back. Egypt, Libya, Algeria, Syria and Yemen combine to produce more than 5 million barrels of oil a day, which is close to 8 percent of global oil production. The longer the crisis exists in these countries, the tougher it will be for other OPEC countries to sustain reasonable oil prices by shoring up spare capacity. Nomura Holdings, a major investment banking firm, pointed out that if Libyan and Algerian production were halted, oil prices could reach as high as $220 a barrel and set the stage for another recession.
While central banks around the world are ruminating over the best possible strategy to counter the effects of high oil prices, we would be wondering what cards the Bangladesh Bank (BB) chief unravels to sustain optimal level of growth and still not worry about rising inflation.
Bangladesh meets 90 percent of its oil requirements from imports. The country might be more than worried if oil hovers around the present $120 a barrel for too long, let alone the Goldman Sachs dreaded forecast level of $200 a barrel. Stakes for Bangladesh are quite high, as last year, Bangladesh Petroleum Corporation (BPC) imported 4.3 million tonnes of oil, which cost $ 2.6 billion to the exchequer. This year, BPC plans to import 4.5 million tonnes of oil and it would be fair to say the initial budget is undergoing multiple revisions against the planned $3 billion outlay.
So how should BB adjust the monetary policy to combat volatile oil prices? Every country has its own unique characteristics and no one policy can be the most apt one. Bangladesh is a country that perennially has high inflation rates and had inflation rates hovering around 8-9 percent last year. On the other hand, Bangladesh has been posting over 6 percent GDP growth and is expected to show a 7 percent rise in output for fiscal 2011-12. Government spending is slated to increase as infrastructure expenditure is all set to foot a bill of around Tk 15,000 crore to develop the country's transport and connectivity systems.
Against a backdrop of the current state of the economy, BB might consider tightening the monetary policy to counter the effects of high oil prices, which eventually leads to a rise in inflation. Since high infrastructure spending also has a direct consequence on inflation, interest rates could be increased to reduce aggregate demand (AD). As a result of a fall in AD, the credit supply is choked as businesses are discouraged from investing or they have to avail credit at higher rates. On the other hand, depositors are encouraged to stash their money away from investment avenues into banks, as savings becomes more attractive. Also, the local currency will see an appreciation in value and help defuse inflationary pressures.
BB might also consider intervening to take stock of the country's present currency situation. At present, the dollar to taka exchange rate hovers around Tk 73, while it was around Tk 70 three months back. While exports in July- February of fiscal 2010-11 marked a rise of 40 percent to about $14 billion, imports marked a higher rise to about $20 billion. Since cumulative imports are higher, the benefit would be greater had the local currency stopped devaluating against the dollar. Asian currencies across the world are at their highest levels against the US dollar since the 1997 Asian financial crisis. The Malaysian ringgit and the Korean won rose to unprecedented highs last month to combat rising inflation.
A decline in foreign aid, deceleration of growth in remittance and wider trade deficits are contributing to higher inflation rates due to a weaker currency. However, a tight monetary policy is subject to time lags and could take more than a year to influence the economy.
On the other hand, the government's ambitious growth target of 7 percent could take a hit as real GDP or potential output could decline. As businesses suffer due to either higher costs of credit or lack of investment climate, productivity declines along with employment levels.
Unemployment will increase due to lower output levels and low generation of income from alternate sources.
Chris Lafakis, a Moody's economist, states, “The fundamental price of oil should be $93 to $94 a barrel plus a $5 per barrel 'uncertainty premium' should have the price of oil hovering around $98 a barrel for 2011.”
Apart from an uncertainty in prices, a leaked US diplomatic cable states a warning from a Saudi oil expert that the kingdom's oil reserves are overstated by 300 billion barrels, which is nearly 40 percent of Saudi's proven reserves. As oil prices are here to stay and oil supplies are uncertain, the government along with BB needs to proactively outline the best form of monetary policy in line with the country's demographics, as early as possible, so as to shield us from higher oil prices at present and in the future.

The writer is a banker and can be reached at [email protected].