Latest monetary policy statement: How realistic?

Wikipedia

Bangladesh Bank announced its monetary policy statement (MPS) for the second half of the current fiscal year (January-June 2012) on January 26. Explicitly or implicitly, the objectives that the MPS seeks to accomplish are:
* Curbing inflation to single digit level,
* Limiting depletion of foreign exchange reserves and establishing external sector equilibrium, and
* Supporting GDP growth of 6.5 - 7.0% in the current fiscal year (FY)
The instrument to achieve these objectives is the containment of broad money growth; primarily by reducing the growth of credit components of monetary aggregates. This article seeks to explore the efficacy of the instrument in realising the avowed objectives.
At the outset, I should mention that in earlier article (DS, February 13, 2011) I had raised questions about the effectiveness of monetary policy in fulfilling the targets relating to monetary aggregates by comparing the targets for June 2010 with the actual outturns. The problem of wide divergence persists.
Curbing inflation
Given the point-to-point rates of inflation in each month during July-December 2011 period, if the annual average inflation is to be brought down to 9%, point-to-point inflation has to come down to an average of 6.7% during January to June 2012. This is obviously a far cry from the actual average of 11.3% during July-December 2011 period.
MPS objective of reducing inflation is predicated on two assumptions: (i) it would be possible to achieve target credit growth and (ii) reduced credit growth would have a benign impact on inflation. The first of these assumptions is open to serious questions. The recent increases in credit growth have been contributed by a huge jump in credit to the public sector reaching a staggering level of 62% in December 2011; private sector credit growth has significantly decelerated.
Bangladesh Bank correctly identifies the underlying causes as high subsidy payments, drastic fall in net foreign aid (the amount received during July-November 2011 was only 7% of that received in July-November 2009) and low level of non-bank borrowing (net sale of National Savings Certificates during July-November 2011 amounted to marginally over one-fourth of the level during the same period of the preceding fiscal year). These problems have been compounded by a relatively slower growth of revenues, albeit at a satisfactory pace in an absolute sense (the growth of tax revenues during July-November 2011 was 16.9% compared to 27.5% in the corresponding period of the previous year). There is hardly any indication in the MPS about how these problems will be resolved. It would, therefore, be unrealistic to expect that growth of credit to the public sector will be halved from 62% to 31%.
The target of growth of credit to the private sector set at 16% (marginally lower than 18% in December 2011) appears achievable. However, recent evidence does not support the assumption that the slowing down of private sector credit growth will greatly reduce inflationary pressure. In fact, private sector credit growth fell continuously from 25.8% in FY11 to 22% in September11 and 18% in December 11; yet inflation has aggravated. The most likely reasons are (a) low growth of private sector credit affects the supply side adversely and (b) the recent increase in inflation is attributable more to the depreciation of exchange rate which stokes cost-push inflation. This point leads to the discussion of the effectiveness of MPS in establishing external sector equilibrium.
External sector equilibrium
MPS hopes that the depreciating exchange rate will accelerate exports. This again is likely to prove unrealistic. Exchange rate has been more or less consistently depreciating since December 2010, but export growth has been consistently falling (it was 41.5% during FY 11, 22.6% during July-September and 14.8% during July- December of FY 12). An in-depth examination is needed to ascertain what is causing this scenario. There may be impediments both on the supply side and the demand side. There has been some improvement in remittance growth, rising from 6% in FY 11 to 9.3% during July-December of the current fiscal year.
Import growth has been falling, but at a considerably slower rate than exports (its growth was 41.8% in FY 11, 23.1% in July-October and 21.6% in July-November of FY 12). Moreover, imports have reached a highly inelastic zone. In terms of L/C opening, during July-November of the current FY, import of food grains fell by 58%, capital machinery by 38% and industrial raw materials by 8%. What increased dramatically was import of petroleum (135%) and it is likely to grow unabated because of the furnace and diesel oil based power plants already commissioned or about to be commissioned.
Given the above scenario with respect to exports, remittances and imports, external sector equilibrium may remain a pious wish.
GDP growth
The target of GDP growth is also unlikely to be achieved. As already noted, falling growth of credit to the private sector will have adverse implications for the supply side. Disbursement of agricultural credit during July-December of the current fiscal year fell by nearly Tk.500 crores over the same period of last fiscal year, that of industrial term loan by about Tk.50 crores. The significantly negative growth of L/C opening for import of capital machinery as well as industrial raw materials, much slower growth of exports than that of imports and drastic reduction in the disbursement of external assistance do not bode well for GDP growth during the current fiscal year.
Furthermore, the banks are suffering from serious liquidity crunch, deposit growth in the banking system has fallen (negative for demand deposit) and with the recent removal of interest rate caps, lending rates have increased substantially. These elements will have to be added as disincentives for private sector investment (which accounts for over 80% of the country's total investment) and therefore GDP growth.
The recently announced MPS contains some useful diagnosis of the current problems in the macroeconomic scene. But in my assessment it fails to set realistic macroeconomic objectives and the expected impact of its stance on those objectives is unlikely to be realised.
The writer is presently a Visiting Professor of Brac University, and a former Advisor to the Caretaker Government, Ministries of Finance and Planning.