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A theory is appropriate as long as it fits into the fact; when a theory doesn't fit in the fact, it's wise to walk with the fact.

Wednesday, October 21, 2015

BB’s goal: Growth Support vs. Price Stability

Why ‘currently’ Bangladesh Bank (BB) should prioritize ‘growth’ more than ‘inflation’?

First, in the first sentence of the ‘Highlights’ of the current monetary policy statement (MPS) for the period of July-December 2015 is just as follows:

This is a cautious but explicitly pro-growth monetary policy stance supporting the 7 percent growth target and the 6.2 percent inflation target for the fiscal year 2016.”

Through this statement, BB made it clear that it weighs ‘growth’ more than other issues of its concern including ‘inflation’, during the current MPS period.

Second, the country targets to reach to 7.0% in FY2016. And with only 0.8% export growth in the first quarter of the fiscal year, what are the means through a reasonable analyst will give the country that targeted growth. It would be curious to know.

Third, Bangladesh wants to be a middle income country by 2021, and for that the government targets to have 8.0% GDP growth by 2020. Historically, export has been the main driver of growth, and will remain so until so many years to come. Then why not the central bank, like other government institutions, focuses more on ‘growth’ than other issues within its jurisdiction?   

Why ‘currently’ the issue of inflation should not be a concern of BB?

Domestic inflation has been on a declining trend, at least in the last two years, mainly because of reduced global food prices and lowered money supply (M2) growth. [Please see the graph of inflation.]

(i)            There is a long-term declining trend of inflation, and then who should care about inflation fear;
(ii)           Inflation trend is stable too!
(iii)          Domestic average inflation is 6.3% in August 2015, which is almost closed to the target inflation rate of 6.2%;
(iv)         Global commodity prices remain stable, and M2 growth of 12.6% in July 2015 remain far below the target M2 growth of 15.6% for December 2015. Unless someone forces, there is no scope of M2 overshooting until December 2015, and then of further rise in inflation. Please remember, BB sets 6.2% inflation target while keeping 15.6% M2 growth. The why one should make BB to be fear about further inflation? Only skepticism rules over the fact, and misguides BB.

How poor!

Why ‘currently’ depressed export growth should be the prime concern of BB?

As BB announced a pro-growth monetary policy, and export is the main drivers of growth, BB should open its door of instruments (e.g., exchange rate) for supporting exports so that it may ultimately bring good news for the 7.0% growth target. Export growth over the last two years has remained quite unstable around the lowest point and negative territory. In general, export growth has been declining since ind-2014. With these kind of export growth, a country just can’t grow, can’t achieve its short-term and long-term goals of reaching higher trajectory of growth (7% to 8% growth).     

Why it’s not possible to improve import growth position without the required momentum in export growth?

First, historically, in the medium-term, trend in import growth has been closely linked with the trend export growth. (Please see the 3-month moving average graph of export and import growth)

Second, import growth of commodities is controlled by those commodities which are used as basic inputs for major export industries, meaning without the increase in import of those commodities, the export growth will remain as it is now.

Third, one just can’t import according to her wish. Import commodities must have a demand in the country. The demand will either come for consumption purposes, or industry uses. Consumption demand is largely dependent on economic condition. Hence, even to increase consumption demand/import, the country should encourage exports, the main driver of economic growth.  

Why exchange rate depreciation shouldn’t be a concern for inflation overshooting?  

First of all, exchange rate depreciation has little impact on the Bangladesh inflation dynamics. This is evident; any economist may check this fact with extensive econometric research.

Second, some experts have been arguing that current exchange rate is not the equilibrium exchange rate, but the equilibrium exchange rate would be far below the current official exchange rate, as the central bank has been intervening in the foreign exchange market to keep it stable. Then, logically, the official exchange rate which is higher than the equilibrium exchange rate, would have been harming the inflation development over the last few years. But in reality, we observe that inflation rate has been on a declining trend, meaning the market exchange rate is not basically harming inflation trends.

Third, some experts also have views that sterilization process to keep exchange rate below the equilibrium rate has been increasing money supply, which is another channel through which exchange rate may harm inflation. But again, if one looks carefully, M2 growth has been always below the target M2 growth, at least in the recent past, despite the fact that the central bank has been doing sterilization for long. This is because net foreign assets under M2 is so insignificant portion (the share of net foreign assets in M2 was only 24.0% of total in June 2015) that may rarely be able to disturb the overall M2 growth. Thus, the concern is unnecessary.         

Probably, the core team of the central bank authorities knows this fact, and that’s why the current MPS is rightly convinced for the necessity of the exchange rate depreciation with keeping the current depressed exports growth in mind, and it’s the right time for the central bank to keep its words by acting accordingly.

Please read the first paragraph of Page 8 of the current MPS:

“While the central bank's purchases of foreign currencies from the market is defusing appreciating pressures on taka and thus on the exchange rate, lackluster performances of exports convince us to lower the value of taka against the dollar and thus depreciate the exchange rate.”

This is really wonderful!

Why other export factors are less important to BB?

Some analysts try to say: other issues such as infrastructure and business climate are more important than exchange rate depreciation for export growth. In this long-run, this is true. But analysts forgot the basic facts: (i) depressed export growth needs quick/short-run action, and dealing infrastructure constraints and appropriate business climate are long-run measures; (ii) while talking about BB’s playground, infrastructure and business climate are not BB’s cup of tea, meaning BB is not in a position to address infrastructure constraints and challenges to business climate. So, it’s better to keep the discussion within the boundary of BB.

BB can use its exchange rate instrument to support export.   

Why analysts keep their eyes shut on real effective exchange rate (REER)?

Can analysts do recall their basic macro knowledge? When REER appreciates, it reflects the erosion of export competitiveness. The following graph shows the trend of REER over the period:  

An analysis of the graph:
(i)    This is the probably longest period of REER appreciation in the history of Bangladesh. The last depreciation of REER took place in November 2012, and after than it has been always the music of REER appreciation. It means, Bangladesh has been losing its export competitiveness since December 2012, or for 32 months.
(ii)           REER appreciation has been rising since August 2014, meaning rising trend in erosion of export competitiveness. This is due to no counter-balance action taken by BB during this period.

Tuesday, October 20, 2015

Bangladesh Development Update: World Bank

World Bank, Bangladesh provides its Bangladesh Development Update. Major issues include:

1. GDP is expected to growth at 6.5% in FY2016;

2. Bangladesh is facing a declining trend in international competitiveness with external and domestic risks.

Link for the update.

Saturday, October 17, 2015