Inflation phobia of central bank hampers growth
The latest monetary policy testifies that the central bank is behaving like the Germans who once regarded inflation as more dangerous than a bomb. In the early 1920s, German workers used to go to their workplaces with wheelbarrows so that they could carry their daily pay back home. Parents were generous to give bundles of German marks to their children because even a bucket of money was not enough to buy a toy for them. The experience of that panic, as some economists argue, made Germany and also Europe adopt tight monetary policy many times even when they didn't need to. Bangladesh Bank (BB), suffering from the same phobia in recent years, has kept on anticipating high inflation even though there is hardly any sign of it.
Usually, election years tend to be inflationary because black money from the candidates and their lobbying groups gets into circulation without the central bank's knowledge. Economists call it "mattress money" or money under the mattress, which in Bangladesh, the candidates use to make themselves seem "kind-hearted" before the election. As a result, the central bank has to be cautious about the supply of money if it shows an upward trend. But doing so even when there is a downward tendency is the result of a phobia that is counterproductive.
The monetary policy for January-June of FY2018 had the perspective to remain easy on growth acceleration by giving some space to private credit, reducing the policy rates, and allowing more depreciation in the exchange rate. These changes are warranted not only to stimulate growth and generate more employment, but also to reduce the augmenting trade deficit looming menacingly in the balance of payment. Instead, the central bank has stifled the spontaneous growth of private credit which is already running above 18 percent, and BB intends to bring it down to 16.8 percent by June 2018. Some may argue that private credit growth is running two percentage points higher than BB's original target of 16.2 percent, and hence BB's recent tightening is justified. That is wrong! BB's initial target was conservative and quite impractical, indicating that doves and bears are dominating the domain of monetary policy at the central bank.
BB policymakers misread the market prior to making the immediate past policy in July 2017 and they have done it again: 1) by resetting the target for private credit growth at another tight number at 16.8 percent against the current number of 18.1 percent, 2) by reducing the advance-deposit ratio (ADR) from 85 percent to 83.5 percent, and 3) by keeping the policy rates constant as before. This kind of punitive tightening is not only anti-market, but also anti-growth. BB seems to be confused, petrified, and self-contradictory in this respect.
The first sentence at the "Highlights" section says: Sharp above-trend upturns in imports and private credit appear to indicate a much-awaited robust pickup in investment and output activities, supported by progress in addressing infrastructural deficiencies, robust domestic demand, and a broad-based pickup in global output, and trade growth. Now the question is, if the recent private credit growth is feeding the much-awaited robust pickup in investment and output, then why is BB putting the brakes on it? If the credit growth is coming as a response to the government's development in infrastructure, why restrict its progress? Wouldn't that be anti-growth and anti-employment? And that also contradicts any central bank's dual mandate that requires maximising growth and employment while keeping inflation at a moderate level.
Not exerting full energy to grow fast when inflation is moderate is tantamount to doing a disservice to the nation's goals of growth and poverty reduction. While institutions should be independent, they must be on the same page when it comes to the nation's key goals. BB seems to have failed to lead the drive for growth once again. Whatever inflation we have in food has come from floods and supply-side disruptions—and they are beyond any central bank's syllabus. Even BB's own projection on inflation is sagging downward to hit 5.7 by June, a pressure mostly coming from the declining non-food inflation. Then, where is that inflation phobia coming from? We could have grown faster had BB been more courageous in policymaking, more supportive to the banking sector, and more ruthless to the defaulters.
The central bank has kept its policy rates (repo at 6.75 and the reverse repo at 4.75) for months and years without showing any relationship with the call money rates. Perhaps, one wonders, the time has come to carve these rates on stone? Our neighbours have showed that policy rates are grounded on market situations, and they changed them numerous times in the recent past. By contrast, the way our central bank is maintaining a stagnant band of policy rates may one day be a subject of study in our textbooks so that children would know that their forefathers had introduced these permanent central bank rates. Inflation eased in the meantime, and the call money rate remained much lower than the band, suggesting that a pro-market reduction in these rates will ease the liquidity crisis now prevailing in the banking sector. But BB seems to have strangled the channels of money growth in the name of prudence, reflecting poor growth in broad money at 11 percent only.
That said, the central bank deserves thanks for bravely stating how the non-market instrument, Sanchaypatra, is destroying the effectiveness of monetary policy and ruining the future of the bond market. This statement alone indicates that BB wants to stand up as an independent institution. Let's hope it will do so someday soon.
Biru Paksha Paul is an associate professor of economics at the State University of New York at Cortland, New York, United States.