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Inflation, forex reserve remain ever defiant

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The finance minister during his closing speech on the Finance Bill for the proposed budget for the  fiscal year 2024-25 on Saturday (June 29) at the Jatiya Sangsad assured the nation that the general point-to-point inflation rate would come down to 6.5 per cent in this fiscal year. He hoped to achieve that target by way of adopting steps like contractionary monetary policy, reducing budgetary deficit, pursuing various austerity measures and so on. Notably, similar measures are already in place for the dual purpose of stabilising foreign exchange reserve as well as inflation. But so far, the inflation has remained at a stubbornly high rate and the net forex reserve has not shown any sign of improvement.  For instance, the point-to-point inflation rate as of May (2024), according to the Bangladesh Bank (BB), was 9.89 per cent. In the previous month (April), it was 9.74 per cent, while in May, 2023, it was 9.94 per cent. Clearly, the figures for inflation rate are fluctuating with no steady decline despite different measures to tame it.

Now, as mentioned by the finance minister, contractionary monetary policy is definitely a tested tool used in the advanced economies to contain inflation. By increasing policy rate (the rate at which the central bank lends money to the commercial banks), the bank interest rate is pushed up. It makes credit costlier forcing businesses to put a brake on expansion and encouraging consumers to spend less and save. The overall impact on the market is reduction in demand  which helps arrest inflationary trend. But it has not worked so far in Bangladesh. The efforts to halt the decline in the foreign exchange reserve in the central bank are also facing similar challenges.  The forex reserve by the end of April, 2024, according the BB was US$25.37 billion. However, this was the gross amount for the forex reserve.  But the net reserve by the end of April, according to the International Monetary Fund (IMF)'s calculation, was USD12.8 billion. According to the IMF's requirement, the net forex reserve  in June 2024 should be USD14.78 billion. To all appearances, this amount of net reserve, as indicated by the international lender, will be hard to achieve. In fact, in its calculation of the forex reserve of a country, IMF does not take into consideration liabilities. From that point of view, any external loan including that extended by the IMF to Bangladesh is also a liability. So, that amount cannot be added to the existing reserve to show an increase in the net reserve situation, though it would increase the gross reserve amount.

Thus the forex reserve has remained as dicey as the inflation rate. The question may arise if inflation affects the reserve situation. Interestingly, a research was done to this effect by the Bangladesh Bank's Training Academy. The result of the research published last May showed that high inflation actually affects forex reserve negatively. It is not hard to see how that happens. To cool the volatile forex market the central bank pumps dollar from its reserve into the market and that causes depletion of dollars in reserve. It is indeed a vicious circle into which the economy has already fallen. 

However, the research in question found that a 1.0 per cent  reduction in inflation can raise the level of forex reserve by 0.11 per cent. It may be recalled at this point that in April the inflation rate was 9.74  per cent. That means over the period of a year since March 2023, the inflation rate remained over 9.0 per cent. Similarly, the net forex reserve, as per IMF guidelines, dropped to US$13.5 billion, while the gross reserve to US$18.6 billion as of May 14. Going by the BB data that was the lowest ever record of the reserve position in a decade. 

Experts have been coming up suggestions on reducing inflation, as the traditional monetary tools like tightening of money supply has yet to show its result. Former Bangladesh Bank governor, Dr Mohammed Farashuddin has reportedly told a recently held seminar on the national budget for FY2024-25 that to arrest inflation the government should follow in the footsteps of the post-independence government led by Bangabandhu. In particular, the former BB governor was for further expansion of selling essential commodities to the consumers through the Trading Corporation of Bangladesh (TCB).   His idea is that through TCB the government would buy the essential agricultural products directly from farmers and sell those to consumers so that no middleman can enter the scene to distort the market and push up the commodity prices artificially. He also suggested making the financial year in line with the calendar year, that is, from January to December. Through this change, he argued, a huge amount of money paid to contractors for construction of various physical structures to fight river erosion, etc. during the months of April, May and June can be saved.

There is no question that market distortion by non-market forces like middlemen, rent-seekers, the so-called syndicates, you name it, all have a role in keeping the inflation high.   At the same time,   to improve forex reserve, the government should also remove the causes that are behind the reduced inflow of migrant workers' remittance and the reduced or non-return of actual export earnings home. Also, wooing more foreign direct investment is one way of  improving the forex reserve situation.  It is not that those in power are not aware of all these issues. But the point is to exert the political will to address those effectively.

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