Economic crisis and inflation

The current economic crisis has developed steadily over the last several years mainly because our aggregate spending far exceeded the national income

A major manifestation of the current crisis is the high inflation which has imposed great hardship on the ordinary people with fixed incomes

Rising inflation and unemployment, falling income, debt burden and greater poverty will play havoc with the livelihood of the ordinary people

To the general public, an economic crisis is a situation when they suffer a significant decline in their purchasing power, that is, the income they earn can no longer support the standard of living they are accustomed to.

Economists are of course not satisfied with such a non-technical definition of a crisis. A Google search of the internet reveals that our economists have defined the current economic crisis expansively in terms of inflation, budget deficit, current account deficit, external debt, the depletion of international reserves, the external value of the taka and non-performing loans (NPLs) of the financial sector. In their opinion, excessively high values of these variables ignited the current economic crisis. Although these two views may appear to be very different, the latter is in effect an expanded technical description of the former albeit on a national scale.

The current economic crisis has developed steadily over the last several years mainly because our aggregate spending far exceeded the national income.  The excessive spending was due mostly to the extravagant expenditure of the government as reflected in its large budget deficits. The excess spending (current account deficit) of the nation in 2021-22 was US$18.7 billion, but the deficit of the government was even larger at US$21.8 billion. The deficits were met mostly by borrowing overseas. The government has essentially predicated its massive development programme on external debt. As a result, the external debt increased by nearly four and half times during the 13-year period from 2009-10 to 2023 December. This has now come home to roost. The exchange rate has skyrocketed, the stock of international reserves has nose-dived, economic growth slowed down, banks are in stress and the inflation rate increased. International rating agencies have downgraded the country which has made foreign loans costlier, and more difficult to come by.

Buffeted by these adverse developments the government has at last awakened to the danger of the balance of payments problems that the country is experiencing. It turned to International Monetary Fund (IMF) for succour.  IMF advisedly pushed it to take some long overdue policy measures as a precondition for a substantial concessional loan. Not having any alternative, Bangladesh Bank shook off its stubborn resistance to policy reforms. It devalued the taka by 28 per cent (against US dollar) gradually in two years to bring it closer to the market rate. It also imposed hefty restrictions on the import of certain category of goods. It put in place some measures to reduce misinvoicing to increase net foreign exchange receipts. All these measures helped to reduce the import payments significantly, and reduced the current account deficit to $3.3 billion 2022-23, and scored a substantial surplus of $4.8 billion in 2023-24 (Jul-Feb).

However, the sledgehammer approach to reduce the current account deficit quickly had some undesirable consequences. It reduced import LCs (letters of credit) of different goods differently. The petroleum product import LCs actually went up substantially and the consumer goods import LCs declined relatively less. The largest reductions in import LCs were registered in capital machinery, intermediate goods, and industrial raw materials all of which are inputs of production. It does not bode well for the future growth of the economy. Furthermore, the taka devaluation and import restrictions led to sharp increases in the prices of the imported essential consumer products as well as inputs. BB was forced to abandon its ‘noy-choy’ game and raise the loan rate considerably to over 13 per cent. It could rise further. These policy measures will slow down the economy and wipe out some of the gains of the earlier period.

Another alarming development is that the Western countries are now facing difficult economic times. Some of them are in recessions while several others have posted low economic growth rates. Since these countries absorb most of our export, there could be a harsh blowback on our economy. Exports to both European Union (EU) and United States of America (USA), two largest destinations of our export, have fallen sharply in 2023. Total export has grown by only 4.4 per cent during Jul-Mar 2023-24. It is unlikely that the export sector will be a strong driver of our economic growth this year.

A major manifestation of the current crisis is the high inflation which has imposed great hardship on the ordinary people with fixed incomes. Low wage and salary earners, pensioners, safety net recipients and those who depend on the interest income of their modest savings would fall into this category. During the last 20 months (2021-22 to February 2023-24) the CPI has increased by about 18.3 per cent. This means that the fixed income earners would now require 18.3 per cent more income to buy the same things as they did in 2021-22. Hence, it can be said that they have lost 18.3 per cent of their purchasing power in just 20 months. This would imply that all people who had incomes higher than the poverty level of income, but less than 18.3 per cent above that level, has now fallen below the poverty line. Those who were already below the poverty line would fall into much more severe poverty and struggle to survive. This is a cruel outcome of a high and accelerating inflation such as the one we are experiencing since 2021-22. The government on whose watch this happened, has no meaningful mechanism in place to reduce the severity of the impact of the inflation.

 Economists usually separate the causes of inflation into two categories: demand-pull and cost-push. The demand-pull factors are those that increase the aggregate demand of the economy beyond its aggregate supply, which pushes up the price level. An increase in money supply could create excess demand pressure by reducing the interest rate. However, recent data on demand variables such as consumer and government spending, business investment and monetary growth do not suggest excessive demand pressure.

The cost-push factors are those that raise the input prices which are then passed on to product prices. The large devaluation of the taka raised the prices of all imported inputs as well as some essential goods. The large increase in the interest rate also raised business costs. All these contributed to the current inflation. Since the taka is still considerably overvalued there is some pressure to devalue it further. This could add to the inflationary spiral.

Economists also add another factor – expectations as an important determinant of inflation. When firms expect the general price level to increase, they may build it into their pricing decisions. Thus, sheer expectations could push up the inflation rate.

Bangladesh Bank is now trying hard to put the economy back on the rail. It reduced the monetary growth during the first seven months of 2023-24 to less than 1 per cent after 9.43 per cent growth in 2022-23. If BB can maintain the tightness of the money market, the price level could decline after a few months. The bad news is that the GDP growth will be sluggish in such a tight situation.

It is less difficult to deal with demand pull inflation, but an attempt to tamp down cost-push inflation with monetary or fiscal policy tools is always painful since the economy will get worse before it can get better.  Rising inflation and unemployment, falling income, debt burden and greater poverty will play havoc with the livelihood of the ordinary people. BB should be aware of its limitations in mitigating these difficulties and use its policy tools judiciously to reduce the adverse impacts of the crisis created largely by misgovernance and policy blunders.

The author is a Professor of Economics, Independent University, Bangladesh. [email protected]