The Financial Express

Spectre of inflation after the pandemic

| Updated: March 20, 2021 21:01:10

Spectre of inflation after the pandemic

The spectre of inflation is stalking, not only Europe, but the whole world. The prospect of high inflation emerging out of the pandemic is becoming more real and threatening as months go by. According to the weekly Economist (February 17), the underlying prices in the euro zone rose in January at their fastest pace for five years. On the other side of the Atlantic, President Biden's $1.9 trillion stimulus package, which includes $1400 cheques for most Americans as unemployment benefit is most likely to overheat the economy once the vaccines allow services sectors to resume their pre-pandemic levels. When that happens, headline data will not be far behind making the tightening of inflationary pressure imminent. World wide, the recovery of commodities markets that collapsed during the pandemic will contribute to headline price rises, according to the weekly. In addition, the recent rise in oil price will begin to impact on the price levels of goods and services in all countries. Besides, the continuation of bottlenecks for supply chains is likely to raise prices across a broad spectrum of goods. Nothing will demonstrate this more dramatically than the higher cost for container space, making shipment of goods, spares and raw materials highly expensive, the increase in the cost for container space going as high as 180 per cent more than a year ago. This will be because the container ship companies have now priced in  the loss in income incurred during the lull in business caused by the pandemic. Boom in demand for tech equipments during the past year has led to a shortage of semi-conductor impacting on the cost of computers and smart phones which have become almost essential items for the majority in developed countries and also for a growing number of the population in the rest of the world. These too will be reflected in the rise of prices of a large number of goods using high tech. But the most potent force in the near future feeding inflationary pressure will be rise in prices as countries try to bridge the gaps between their stimulus expenditures and internal resources mobilised through taxes or available through the financial sector. Already the withdrawal of a cut in VAT in Germany has led to a year-on-year inflationary rise from 0.7 per cent to 1.6 per cent. In the UK, the Chancellor Rishi Sunak will not fail to use the election of Joe Biden as the excuse for a big budget increase in corporate tax rates, arguing that the US President is also planning a rise in business taxes. In fact, President Biden and his treasury secretary have already proposed an increase in corporate rates tax from 22 to 28 per cent. Sunak wants to keep Britain's corporate tax competitive with other G-7 countries and that could allow rates to rise to 25 per cent or higher. Other countries -- developed, emerging and developing -- would take recourse to the same measure to raise taxes, it can be concluded. The result will be increases in inflations from their present levels.

Much will, of course, depend on what items the stimulus benefits are spent by the recipients. If the expenditures are more on consumer goods and services and not for productive purposes, the money injected by the governments into the economy during the pandemic will add to the inflationary pressure. In this respect, the experiences will vary from country to country. In countries like Bangladesh money given to the poor and low income groups as subsistence assistance has been much less than to industries, particularly large ones. The immediate impact on the prices of consumer goods has not been significant because of this. But to the extent the stimulus package has been provided for from fiscal space, the budget deficit will widen for the next fiscal year, requiring raises in tax rates, even imposition of new taxes. So far corporate tax is concerned, it being already high in Bangladesh (35 per cent), it may escape the same fate as in America or in the UK. Therefore, the brunt of a higher tax regime will have to be borne by a wide array of taxes on consumer goods, adding to inflationary pressure.

Whether the impact of external factors like change in oil price, higher cost of container space and higher prices of imports or the increase in domestic tax rates will give rise to inflationary rise and to what degree will depend on the 'inflation shortfall' of each country. 'Inflation shortfall' is measured by the actual inflation and the target rate fixed by the central bank. In America and Japan where the inflation rates have been below the target band (2.0 per cent), increase in headline inflation will not be a cause for concern, whether stemming from stimulus expenditures or consequent tax raises. Because of the inflation shortfall being below the target, the Federal Reserve in America has held fast to its decision to keep interest rates low and to keep buying bonds to add to the money supply. Japan is doing the same, in continuation of 'Abenomics' (easy money and low rate of interest). In fact, the Fed has decided to overshoot the 2.0 per cent inflation target in order to make up for the present shortfall to give a shot in the arm of the economy. But soon there will be a limit to its new average inflation target for a large overshoot beyond the targeted rate. The faster prices rise, the sooner the easy money policy would be wound down. Higher interest rate to fend off the resulting inflation will not only hit the stock market adversely but will also raise the value of dollar which in turn will lead to outflow of dollar currency from emerging economies, increasing their budget deficits. While America has a temporary space now for higher inflation because of the shortfall below the target rate, the euro zone has little prospect of sustaining higher inflation as its price levels are more or less near the target rate of inflation set by the European Central Bank (ECB). This is because the basic rate of interest was not reduced by ECB as in America during the pandemic. Moreover, the budget deficits of most euro zone countries, except Germany, are already near or beyond the 5.0 per cent ceiling agreed upon by the member countries for budgetary discipline. So the stimulus packages in the euro zone will not only involve higher budget deficits but also higher inflation in EU. According to Martin Wolf, there will be surge in inflation, quite likely more than 5 per cent, or even on the order of 10 per cent in 2021 as a result of present fiscal and monetary largesse in the form of stimulus packages (The Financial Express, November 19, 2020). 

In Bangladesh the target set for inflation in the last budget was 5.5. The expansionary monetary policy of the Bangladesh Bank (BB), following the pandemic, has led to higher inflow of liquidity to implement the stimulus packages announced by the government. Besides, the central bank's downward revision of repo rate and the cash reserve ratio (CRR) has boosted the monetary flow. The net foreign assets (NFA) contributed by remittance, export earnings and foreign aid have also added to broad money (M2) and Reserve Money (RM). Purchase of US dollar by Bangladesh Bank from commercial banks to stabilise the exchange rate has also contributed to higher money supply in the economy. Substantial amount of money has been received as remittance during the pandemic, augmenting the money supply. The bulk of this amount is being spent by their recipients on consumer goods adding to inflationary pressure on both food and non-food items.

On the supply side, the availability of goods, both food and non-food, is going to be costly for the rest of the present fiscal. A news items in Daily Prothom Alo (March 7) has reported increases in the prices of essentials like soyabean, sugar, rice, wheat, milk powder etc., because of increase in import costs, a combination of rise in shipment cost and price rise of the items in the exporting countries. Even the prices of industrial raw materials, liquefied gas and oil are now on the rise because of increase in their prices in the international market. According to the news item, cost of container space has increased from 33 per cent to 122 per cent during the past year which has been reflected on the prices of imported goods. Prices of food grains have increased consistently over the last nine months in international markets, increasing the price index to 116 basis points, a rise seen only in 2013 according to FAO.

In Bangladesh, the inflation target has already been exceeded by 3 basis points, taking it to 5.8 per cent. There being no inflation shortfall as in America or Japan, Bangladesh cannot hope to absorb the growth in money supply as mentioned above. This will be exacerbated when there is raise in tax rates during the next budget. So, it can be presumed that the inflation target of 5.5 per cent fixed in the last budget may go as high as 7 per cent during the first half of the next fiscal. Only improvement in the supply  chain of goods leading to decrease in the price levels and increase in domestic food production reducing imports can bring down the inflation rate from the projected 7.0 per cent during the next fiscal. Therefore, the next fiscal year is going to be a critical period both for recovery of the economy and  build up of a growth momentum, as in the pre-pandemic period. Bangladesh can address the problem of inflationary rise in prices only partially, the rest will depend on other countries with which we are integrated through economic globalisation. In short, the prospect of high inflation appears very real at this point of time, one year after the onset of the pandemic that has devastated almost all economies in the world. The question now is how can it be contained within reasonable limits and how soon. The answer will depend on prudent domestic economic policies and international economic cooperation in a new spirit of globalisation that does not 'leave any one behind'.


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