15 days ago

Rising inflation and deepening currency crisis hit Bangladesh

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According to the Financial Express (March 13) inflation in Bangladesh resurged in February this year to 8.78 per cent. In fact, inflation has been on the decline since September, 2022 until last month when it started to show an upward trend. Inflation indeed peaked 9.52 per cent in August last year. The annual inflation rate is largely underpinned by rising prices of food and fuel. Surging food and fuel prices are eating into people's spending now.

There are a number of factors behind the rising trend in inflation in Bangladesh. They include price rise of essential consumer items, in particular food and fuel, slow growth in agriculture, rise in the world prices of food items and  sharp depreciation of taka against the US dollar. The recent inflationary surge has also been exacerbated by the Russia-Ukraine military conflict.

For a very large number of households in Bangladesh rising inflation poses a significant challenge. Rising inflation can erode value of real wages and savings, making households poorer thus creating a cost of living crisis. The effects of the cost of living crisis are not felt equally. It is the low to lower middle-income households who are most vulnerable to the inflationary effects. The erosion in the standard of living for the vast majority of people in the country will give rise to widespread discontent and grievances among consumers.

Rising inflation worsens inequality or poverty as it erodes income and savings of poorer households than those of wealthier households. The BBS which computes the Consumer Price Index (CPI)  to estimate the rate of inflation in Bangladesh uses a basket of goods (422 items) considered to represent average consumer needs. But the actual pattern of expenditures varies significantly across various income groups. The share of food consumption expenditure by poorer households to total household consumption expenditures in Bangladesh is about 60 per cent, squeezing poor peoples spending power. The recent increases in food and energy prices Bangladesh could disproportionately impact the poorer groups relative to other groups.

The CPI is not an ideal indicator to measure changes in the cost of living. While the CPI measures price changes, cost of living inflation is the change in spending by households required to maintain a certain level of standard of living. The CPI also does not adjust for changes in household spending patterns resulting from changes in relative prices of substitutes. The CPI, therefore, is affected by substitution bias.

If inflation continues to be high and persistent, Bangladesh Bank may respond by raising interest rate benchmark. The interest rate regime in Bangladesh is expected to be further  liberalised in line with the IMF recommendations. In that event, banks will respond by increasing their lending rate. Such a rise in the lending rate will cause a reduction in the volume of credit available to the private sector, thus  negatively impacting on economic growth. This weakened credit supply will also be reflected in the declining ratio of bank credit to GDP.

Furthermore, high inflation will eventually push the real interest down, or even can become negative when inflation is higher than the required rate of return with implications for non-banking financial sectors as well. These sectors include insurance and pension fund. The real returns on stock market and bond market instruments  may also decline. In summary, high inflation negatively impact on the financial sector, both through banking and non-banking channels.

In mid-January this year Bangladesh Bank raised the benchmark rate by 25 basis points to 6 per cent from 5.75 per cent with the aim to contain inflation but that did not work in the short run as inflation resurged again in  the following month. Bangladesh Bank in a statement also said it would pursue a "cautiously accommodative" policy stance to contain inflationary and exchange rate pressures and also pursue the goal of economic growth and employment generation. But such a policy stance will only decelerate growth while helping to moderate inflation.

Now inflation is one of the several worries facing Bangladesh. A rapidly changing global economic climate leaves not much  manoeuvring space for policy as the country's macroeconomic parameters are  impacted by the recent global events. Bangladesh Bank like many other central banks in the Global South faces complicated underlying policy challenges. During such a challenging time central banks including Bangladesh Bank are likely to face increasing political pressure to pursue their mandates and their independence.

The country is now also faced with depreciating currency, declining foreign exchange reserves and remittances. These issues need very urgent attention. In fact, in the face of deteriorating foreign exchange reserves, Bangladesh sought funds from the IMF amounting to US$4.5 billion. Initial agreement for the loans was reached in November last year.

Global macroeconomic shocks since 2020 have been devastating for countries in the Global South including Bangladesh. Bangladesh with fewer financial resources and less economic resilience has weathered though these crises better than many other countries in South Asia.  But now rising price levels, falling foreign exchange reserves and remittances along with a depreciating currency pose serious economic challenges for Bangladesh. The ongoing banking crisis largely caused by loan defaults further added to the ongoing economic crises in the country.

Bangladesh needs to take urgent actions to stabilise its economy. Now central banks are expected to achieve far more than performing the traditional role - to maintain price stability. This means the scope of monetary policy have to change to deal with the emerging challenges.

S&P Global Ratings in a recent report pointed out that high commodity prices, surging domestic demand and tighter monetary conditions have caused net outflows of foreign exchange and a depreciating currency. The taka has already depreciated by about 25 per cent over the last one year or so and still remains under tremendous downward pressure. Bangladesh also has substantial capital outflows and a deteriorating balance of payments and a very weak financial system. But it is depreciating taka that will increase financial risks and affect economic growth.

Bangladesh is now facing much greater external pressure, resulting in the depreciation of the taka against the US dollar and other major currencies. The US dollar index over the last one year appreciated by more than 15 per cent. Interest rate hikes by the US Federal Reserve have caused the surge in the value of the US dollar. One of the consequences of surge in the value of the US dollar  is the surge in inflation in countries like Bangladesh because so many commodities such as food grains, oil and gas are priced in the US dollar. Power companies in Bangladesh are faced with acute dollar shortages to import fuel impacting not only power supply but also fuel supply for irrigating rice fields.

Further rises in US interest rates can cause much more widespread currency distress for Bangladesh and many other developing countries given their declining levels of foreign exchange reserves and rising debt volumes. Now more than 20 countries including Bangladesh have sought help from the IMF to deal with their current financial crises.

Tighter monetary policy, and higher real interest rates, high food and fuel prices with weak to negative household income growth are expected to sap economic growth in Bangladesh.

Interest rate rises in the US will continue, albeit at a slower rate, despite the current banking crisis in the country to tame the rising inflationary pressure. That will continue to slow down the US economy thus negatively impacting on  Bangladesh's principal export -- garments to the US while raising the costs of dollar denominated imports of food and fuel thus widening the current account gap. Bangladesh is also having problems with the capital account resulting from a fall in FDI. In fact, during the FY 2021-22, Bangladesh registered a record current account deficit of US$17 billion. This is despite traditional export boosting effect of a depreciating domestic currency (the taka). In fact, a stronger US dollar dampens global trade flows as it remains the principal currency for global trade transactions.

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