Inflation and the upcoming budget

The country's new finance minister and a new state minister for finance are now busy finalising the national budget for the upcoming fiscal year (FY25). It will be the nation's 53rd annual national budget, and the ongoing pre-budget consultations suggest that the government will enhance the outlay modestly for the next fiscal year. During the last one and half decades, the country saw a 14.55 per cent increase in the proposed budget on average yearly. Nevertheless, an increase in budget outlay by a single-digit rate was visible in FY21 and FY22.  Budgets in the upcoming year, or FY25, will also rise at a similar rate, mainly due to resource constraints amidst the current economic conditions that are not quite robust.

Several critical things have emerged as the primary backdrop of the next fiscal year's budget.  Curbing inflation is pivotal as the country struggles with soaring prices. In his budget speech last June, the immediate past finance minister acknowledged the growing pressure of inflation. He said that the increase in import costs due to the disruption caused to global supply chain by the Russia-Ukraine war and depreciation of taka led to a surge in domestic inflation. He also added that it could not be possible to keep the annual average inflation within the targeted ceiling of 5.6 per cent in FY23.

The finance minister was right. Bangladesh Bureau of Statistics (BBS) data showed that annual average inflation stood at 9.02 per cent at the end of FY23.  The minister, however, was optimistic about bringing down inflation in the next fiscal year (FY24). He presumed that the prices of fuel, food, and fertiliser in the global market would decline, and fuel prices would be adjusted in the domestic market. Moreover, government initiatives to keep the food and supply systems regular will continue. So, he stated: "The inflation will remain much controlled in the next fiscal year [FY24] and the annual average inflation is expected to stand at around 6.0 per cent."

Here, the then finance minister was wrong. Annual average inflation stood at 9.61 per cent at the end of the third quarter of the current fiscal year. There is no chance that the inflation will come down to even below 9.0 per cent at the end of FY24. Due to the continued upward pressure of inflation from the beginning of the current fiscal year, the government has already revised the inflation ceiling to 7.50 per cent. Bangladesh Bank has also aligned its half-yearly monetary policy with the target. With only two months in hand, inflation seems to prevail above the target by the end of the current fiscal year.

Thus, the new finance minister is facing the daunting task of formulating a budget in a high inflationary environment. His primary challenge will be to curb inflation, with the next budget potentially setting the inflation ceiling at 6.50 per cent, as reported in the media recently. The feasibility of this target is a matter of question, as curbing inflation now hinges on many external and internal factors. Thus far, monetary policy tools have been employed, guided by the theory of money supply, in an attempt to reduce inflation.

Generally, higher money supply growth pushes up inflation as 'too much money chasing too few goods'. In other words, prices rise due to a mismatch between demand and supply. An increase in demand or a decrease in supply for any product will generally cause its price to rise. Thus, national inflation reflects the mismatch between aggregate demand and aggregate supply. Now, the central bank has stepped in to reduce the flow of money supply by raising interest rates to contain the upward pressure of inflation. 

However, the current trend of inflation in Bangladesh shows that monetary policy is inadequate to curb inflation, and it requires necessary manoeuvre through the fiscal policy, which is not adequate in the country.  Fiscal policy has three essential components - government revenue, public expenditure and deficit financing by borrowing. As the new finance minister has decided to keep the budget or the annual spending outlay in check for the upcoming fiscal year, it is basically consistent with the move to contain inflation. The proposed public outlay for the next fiscal year is likely to be 5 per cent higher than the revised outlay of the current fiscal year.

The modest increase in the budget will be counterbalanced by a lower growth of gross domestic product (GDP), projected at 6.75 per cent for the next fiscal year, down from the original 7.50 per cent projection for the current fiscal year. The government has already revised growth the rate to 6.75 per cent for FY24, and it remains to be seen whether this revised target will be met. It seems that economic growth at a reduced rate is now a necessity to contain high inflation, although there is no guarantee of achieving this goal.

Typically, growth in GDP results in an increase in inflation. It happens due to higher demand and (or) reduced supply. Again, higher GDP growth may push inflation too high and make it difficult to contain. From these theoretical considerations, it may be said that there is a direct relationship between growth and inflation. In that case, lower GDP growth should cool down the inflation. Nevertheless, it all depends on some other factors, like the nature of growth and inflation.

So, the question remains: Will the modest budget increase in the next fiscal year be able finally to rein in high inflation? This critical question is yet to be answered. Until then, the debate and speculation on the matter will continue. 

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