Sustainable fight against inflation | The business standard

Persistent near-double-digit inflation is hurting consumers badly. There is almost a consensus in Bangladesh that tackling inflation is the top policy priority.

Why is inflation so persistent and what can be done to tackle inflation comprehensively and sustainably?

There is considerable debate over these issues. One populist argument is that inflation is primarily due to the profiteering and greed of “unions” who use their market power to continually raise prices. Some argue that the inflation is caused by the large devaluation of the Bangladeshi currency, which pushes prices up.

The union theory of inflation is misleading. There is no evidence for this. It also raises the question of why inflation was so much lower between 2013 and 2022 despite unions. In terms of devaluation, although there was a substantial devaluation between January 2022 and September 2023 that put pressure on costs, the Bangladesh Taka has been relatively stable over the past 12 months. In addition, global commodity prices declined considerably after August 2022, which tended to offset the negative effects of the Taka devaluation.

In a market economy, prices are determined by supply and demand. Although there are market imperfections related to information flows and efficient supply chain operation, especially for perishable products, which can influence periodic price outcomes, overall, I believe that prices in Bangladesh are based on the forces of supply and demand. Just as prices rise when demand increases or supply decreases, the rate of change in prices (inflation) is influenced by the rate of change in demand and supply. If aggregate demand increases faster than aggregate supply, the rate of increase in the price level (inflation) will increase. There are many factors that influence supply and demand. Sustainably combating inflation requires that policies focus on ways to reduce growth in aggregate demand while stimulating growth in aggregate supply.

Application management policies: In my book “Bangladesh Stabilizing the Macroeconomy”, published in December 2023, I provided evidence that the fundamental factor fueling inflation in Bangladesh since August 2022 was excessive domestic credit, mainly public sector credit, due to packages big covid incentives. -19 period (FY2020-FY2021) financed mainly through budget deficit and money creation, continued financing of fiscal and quasi-fiscal deficits (FY2022-FY2023) through money creation and interest rate control (July 2020 – November 2023) which pushed the private sector credit growth and reduced bank deposit growth.

Monetary policy correction began in November 2023, when the interest rate was deregulated and the financing of the budget deficit through money creation was stopped. These policies were strengthened in May 2023 and further tightened in August-October 2024. The interest rate is now fully deregulated and monetary policy is heavily focused on controlling inflation. The monetary policy adjustment is a smart policy move and should be expected to have a strong positive impact in reducing aggregate demand pressure on inflation.

I also argued in my book that monetary policy alone cannot reduce demand pressure on inflation and requires a strong fiscal correction. On the positive side, the fiscal deficit was narrowed considerably in FY2024. But this correction came through spending cuts and not revenue growth. The quality of the fiscal adjustment is not good, as relying solely on spending cuts will have adverse effects on the supply side through reductions in public investment and GDP growth. While the caretaker government rightly focuses on quality spending by reducing waste and leakage, it is well known that many necessary public investment programs related to human development and water management are grossly underfunded. Excessive focus on spending cuts to reduce aggregate demand is unlikely to be sustainable and the effort needs to shift to greater revenue mobilization through fiscal and state-owned enterprise (SoE) reforms.

Supply Factors: Many observers are disappointed that, despite considerable monetary tightening, inflation remains stubbornly high, near double digits. There is also some skepticism about whether monetary tightening has gone too far without favorable results for inflation. This skepticism, however, is based on a partial view. A fuller analysis will show that the reason why the full benefit of the tightening of demand to reduce inflation has not occurred is because of a large drop in supply that has occurred over the past two years.

The depth of the supply crunch is indeed worrying. The most immediate supply constraint is the sudden drop in imports. Between FY2022 and FY2024, imports fell by 22% from $86 billion in FY2022 to $67 billion in FY2024. Imports fell further in the first quarter of FY2025 by 1%. Import discounts are extensive. Food and consumer goods imports fell by 17%; intermediate goods by 24% and capital goods and other goods by 21%. Besides contributing to escalating domestic prices, these deep cuts in imports paint a rather grim picture of an economy in decline.

It could be argued that the increase in imports in FY22 was largely the result of accelerating global inflation. World inflation and commodity prices of key imports have declined and stabilized since then. So a decrease in the value of imports is normal. However, looking at the long-term trend, Bangladesh’s import level, consistent with 7% GDP growth and 5-6% inflation rate, should have increased from USD 61 billion in FY 2019 to USD 86 billion in FY 2024, while real imports increased only marginally. to USD 67 billion in FY24, reflecting deep above-trend import cuts. Also, exchange rate stability based on such deep reductions in imports is not sustainable.

A second supply-side factor is slipping growth in the manufacturing sector, which supplies the bulk of non-agricultural domestic consumption goods. The output growth rate fell to 6.6% in FY2023-FY2024, down from an average of 12% in FY2021-FY2022 and 14% in FY2018-FY2019. If the trend does not reverse, the output growth rate could further decline to 4-5% in FY 2025. This deep slide in manufacturing output growth has contributed substantially to the slowdown in aggregate supply growth. Although the sharp decline in manufacturing output is disproportionately affected by turbulence in the textile and RMG sectors, the reduction in growth has spread to a wide range of activities affecting the supply of consumer goods due to intermediate cuts in imports, energy constraints and, most recently, the deterioration of the rule of law

Finally, recent floods have created some short-term adverse effects on agri-food prices in August-September 2024. There are currently reports of better supply of vegetables in October, which has reduced inflationary pressures on these products. Continuous monitoring and support of agricultural production is essential to manage inflationary pressures.

The way forward: With the exception of domestic resource mobilization, demand management policies are largely on track. The effort must now focus on improving the quality of the fiscal adjustment by raising domestic revenue through tax system reforms and SoE reforms. The agenda is well known and documented in detail in my book on Macroeconomic Stabilization. The policy effort to control inflation on a sustainable basis must now turn to the recovery of supply growth, both from imports and domestic production.

Bangladesh is an import-dependent economy for a wide range of products, and the smooth flow of imports is essential for both inflation and economic growth. From an inflationary perspective, efforts are being made to increase imports of essential food products and reduce their cost by reducing trade taxes. This is a sound policy move. Overall, there is a need to rationalize the trade protection regime with a view to drastically reducing trade protection, which will be beneficial for both inflation control and export growth. In addition, all non-tariff import restrictions imposed between 2022 and July 2024 to reduce imports must be reviewed and removed to facilitate the flow of imports.

Reclassification of domestic production, mechanisms to support agricultural production, including the supply of fertilizers and agricultural credit, must be strengthened. Taxes on imported agricultural inputs should be reduced. The agricultural produce distribution system should be strengthened by eliminating all octroi/toll collection ports.

Concerted political attention should be given to examining the constraints in manufacturing production and removing those constraints. In particular, the recovery of the RMG sector is essential for export growth, which will support sustainable import expansion without putting undue pressure on the exchange rate. For the manufacturing sector as a whole, easing the supply of intermediate imports will help pick up production growth. In addition, strong efforts are required to ensure uninterrupted power supply to the production units. Finally, increased attention to law and order is essential for the recovery of the manufacturing sector.

In conclusion, sustained inflation reduction is a medium-term challenge that requires strong policy action to restore import expansion, regain momentum in manufacturing output and ensure strong agricultural output. In addition, prudent macroeconomic management is required, consisting of market-based exchange rate and interest rate policies, low fiscal deficits based on domestic resource mobilization, and sound public spending policies to support energy, agriculture, water, transport and development services human. In the short term, focusing on food imports with low or zero trade taxes and increasing social protection spending will help reduce the burden of high inflation on the poor.

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Sadiq Ahmed is the Vice President of the Bangladesh Institute of Policy Research. He can be reached at (email protected)

Sadiq Ahmed is the Vice President of the Bangladesh Institute of Policy Research. TBS sketch

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Sadiq Ahmed is the Vice President of the Bangladesh Institute of Policy Research. TBS sketch