Money matters and the economy

Ample discussions regarding money supply and its significance in the economy have taken place recently. Why is it so important? Any country's prime objective is to attain a high economic growth and overall macroeconomic stability. Control of money supply and interest rate is executed through monetary policy which helps attain the prime objectives.
So how does the alteration in monetary policy affect the economy? In a developing country like Bangladesh, the level of investment is crucial for attaining higher economic growth. If Bangladesh is to attain the middle-income status by 2021, it is imperative that it increases its investment to GDP ratio. However, in recent years, total investment hovered within a narrow band of 25 percent of GDP. Countries with the middle-income status have investment to GDP proportions ranging from 35 percent to 40 percent. This can depict how far behind Bangladesh is in the race to attain higher growth and how vital it is to increase investment levels.
Now this is where a prime importance of monetary policy comes in. As investors are concerned with the cost of borrowing money from banks, i.e., interest rates, Bangladesh Bank alters broad money growth rates to modify interest rates. If the investment climate is favourable, the central bank may pump in more money into the economy to accommodate the rise in demand for credit, which in turn can lower interest rates and increase investments. Conversely, if the BB wants to tame a high rate of inflation, it will reduce money supply from the economy. One can naturally infer that increasing money supply and lowering interest rates (quantitative easing) may be ideal in order to promote investment in Bangladesh. However, this may not be true.
It has persistently been argued that one of the main reasons for lower levels of investment is the recent 'contractionary' monetary policy pursued by the BB. Past statistics, however, portray a different scenario. Broad money growth rates in fiscal 2010 and 2011 have been 22.4 percent and 21.3 percent respectively, which were higher than the targets set. Private sector credit in those years grew by 24.2 percent and 25.8 percent, whereas its previous ten-year average was 15.7 percent.
Since the private sector was taking loans at an astounding level, one can indisputably expect a rise in investments by the private sector. On the contrary, private sector investment remained practically unchanged. So where were the loans taken by the private sector all stashed? The formation of the stockmarket bubble and its burst in recent years can be attributable to this. Prices of real estates and lands swelled and inflation surged and reached double digits. The repercussions of these were immense: people lost their hard earned money and savings when the stock bubble burst; high prices of real estates and land made these assets out of reach for many people and adjoined to further income inequality. High inflation acted as a tax on income and peoples' real income fell. Needless to say, investments in these sectors hardly act as a catalyst for economic growth. Now why were not there any growth-augmenting investments by the private sector? This may be because there are several barriers that discourage people from investing such as a lack of energy, political instability and a deficiency in infrastructure.
The BB in its recent monetary policy opted for tightening the broad money growth rate to reduce inflation from 7.7 percent to 7 percent. Private sector credit target has been cut to 15.5 percent from 18.5 percent. Some say that the BB should have gone for quantitative easing and lowered interest rates which could have revived investment. However, the private sector credit growth has been plummeting since July 2012. It is unlikely that the private sector will undertake investments in the face of intense political turmoil. An argument can be placed saying that private sector credit growths were much higher than current 11.4 percent in previous election years, so why not go for quantitative easing to generate investment?
However, in the past, the length of political turbulence could be predicted as elections were held on time. Since the end of the previous BNP regime and takeover by the caretaker government, there has been perplexity about how long the political chaos will last. Contrary to previous, this time the investors cannot predict how long the slump in economic activity will persist and thereby cannot calculate the depth of their risks.
There are certain anomalies in the conduct of monetary policy as well. Firstly, in recent years, the BB could not adhere to the targets it set for broad money growth as it was always higher than the targets. In May 2013, the rate was 18.1 percent against a target of 17.5 percent. The BB mostly does this by buying off dollars from banks and thus pumps the taka back into the system. Dollars are bought to keep the taka from appreciating since an undervalued currency augments to export competitiveness. This dilutes the efficacy of monetary policy and entails risk of high inflation and asset bubbles. This also makes imports expensive and can discourage investors from buying imported machinery.
The second problem lies in the occasional lack of harmony between the monetary and fiscal policies. For instance, in fiscal 2012, government borrowing from the banking system surged mainly due to a rise in subsidy payments. This was a time when monetary policy started to contract. As a result of high borrowing by the government, private sector was 'crowded out' during that time. One way by which the fiscal gap could have been bridged is by the issuance of sovereign bonds (bonds issued by national governments in foreign currencies). However, these bonds will not surface until the arrival of the next government.
Prudent application of monetary policy is highly necessary for Bangladesh as it cannot only spur investment but also help attain the objectives required for economic growth.

The writer is the head of research at The Daily Star and can be reached at [email protected].